Lower interest rates continue to buoy financial markets, but ongoing trade tensions and possible currency manipulation provide a volatile backdrop. Some notable developments in the first month of the new financial year include:
- Both the RBA and the US Federal Reserve lower official interest rates
- Australian and US share markets hit new all-time highs
- The pace of economic growth in major global economies slows
The end of July saw the US economy enjoying 121 months of consecutive growth, the longest run since records began in 1854. It is more than twice as long as the average post-WWII expansion. America’s economy accounts for a quarter of global output. But growth is slowing, with the second quarter annualised growth rate dropping from 3.2% to 2.1%. Partially in response to a weaker growth outlook, the US central bank lowered the official cash rate by 0.25%, stating it was a “mid-cycle adjustment to policy”. Markets were perturbed as this did not clearly define the future direction of interest rate policy and initially sold off. As is the case in Australia, US employment is strong and corporate earnings growth, though not as strong as the previous quarter, is not signalling recessionary warnings. The threat of a slowdown due to a deceleration in global trade appears to be a key consideration of the central bank. Nonetheless, the combination of lower interest rates and company earnings announcements that were better than anticipated, saw the US S&P 500 Index rise 1.4% for the month.
China continues to reform and open its economy, announcing that foreign investors would be allowed to take full ownership of investment banks and insurance companies from 2020 – a year earlier than previously announced. News on the economic front was not as promising, with growth the slowest since current reporting methodology was adopted in 1992 at 6.2% annualised for the second quarter of 2019. The equity market (CSI 300 Index), though, recorded a respectable return of 1.1% for the month. However, escalating political tensions associated with domestic civil liberties in Hong Kong weighed on sentiment there, with Hong Kong’s Hang Seng Index down 2.3%.
Germany, the economic powerhouse of Europe, saw factory orders fall 8.6% in May, the sharpest fall since 2009. No doubt the China/US trade conflict is having a negative impact on both confidence and forward orders of German exports. The German share market (DAX Index) was down 1.7%. Across the Channel, the UK market (FTSE Index) rose 2.3%, reaching an 11-month high. This rise was on the back of the falling Pound, as the possibility of a disorderly Brexit becomes more of a reality. Boris Johnson became the UK’s Prime Minister after Theresa May resigned following the Government’s inability to negotiate a Brexit deal.
Iron ore rose 4.3% in July, the eighth consecutive monthly gain. The giant Brazilian ore miner, Vale, has confirmed that more than a third of its production shut down after the tragic Brumadinho Tailings dam disaster. Full production is unlikely to return for at least three years. Copper fell 0.8% and is now down over 8% in the last three months. Oil rose slightly as tensions continued in the Strait of Hormuz. The gold price also strengthened in response to increasing geopolitical uncertainties across various parts of the globe.
In July the ASX 200 Index delivered its seventh straight month of gains and finally crossed its pre-GFC all time high of 6828.7 set on November 1, 2007. The market rose a healthy 2.9%, with smaller companies outperforming with a gain of 4.5%. We are now in the 2018/19 reporting season, with company results and outlook statements providing important information to set earnings expectations for the year ahead.
The best performing sector last month was Consumer Stables, up a solid 9.8%, followed by Health Care (up 5.9%), and Consumer Discretionary (up 4.9%). Though there were no negative performing sectors, the laggards were Resources (up 1.1%), Energy (up 1.7%) and the interest sensitive Financials (up 1.7%), Utilities (up 1.9%) and Property Trusts (up 2.6%).
Fixed Interest & Currencies
The RBA (Reserve Bank of Australia) followed up the June interest rate cut with another in July for a record low 1%. The RBA also signalled it would not back away from further cuts if the jobless rate failed to fall further. There are now nine central banks, including Australia, with an interest rate of 1% or less, with four banks at 0% or less. Bond yields and the Australian dollar weakened (as desired by the RBA), with the 10-year government bond yield closing out the month at 1.19% and the $A dropping to US 68.9 cents.
Outlook and Portfolio Positioning
The global economic and geopolitical backdrop is continuing to present more risks to the general economic and financial market outlook. Despite this, equity markets have continued to take their lead from monetary policy settings and rallied in response to lower interest rates. Although this can be justified on a relative valuation basis, risks to company earnings cannot be ignored and a cautious approach to equity allocations is warranted. Profit taking and ensuring equity holdings are not above neutral benchmark allocations remain appropriate.
Prospective yields from defensive investments have continued to decline in line with the easing in monetary policy. With longer term bond yields at historic lows, there is little compensation for investors in taking on interest rate duration risk (i.e. investing in long dated fixed interest bonds). Investors should also avoid the temptation to seek increased yield through inappropriately high levels of credit risk, with corporate debt exposed to some of the same risks faced by equity markets currently. Although variable rate investment grade defensive investments are now offering very little in the way of return, capital protection has become the primary objective of the defensive component of portfolios; as well providing a potential funding source to allocate to growth assets should cheaper valuations emerge in the future.
Any advice provided is of a general nature and does not take into account personal circumstances. Any decision to invest in products mentioned here should only be made after reviewing the relevant Product Disclosure Statements. Past performance is not a reliable indicator of future performance. No revenue has been received by Accru Financial Planning as a result of this article.
Accru Financial Planning Pty Ltd is the holder of Australian Financial Services Licence No. 341864 issued by the Australian Securities and Investments Commission.