The S&P/ASX 200 Price Index delivered its best quarterly return for nearly a decade, with the index rising by 9.5% to the end of March. The MSCI World ex Australia Net Total Return Index (AUD) also delivered a marquee quarter, with the index gaining 11.65%. In March, REITS delivered the strongest returns across most markets (MXWD: +4.5%), with sagging 10-year bond yields boosting the sector. This dynamic had the opposite effect on Financials, which fell in most regions through the month (MXWD: - 2.7%). The DOW returned 11.2% for the quarter, the DAX 7.5%, FTSE 8.2%, and the Shanghai composite 24%.
In Australia Materials was the best performer for the quarter, delivering 15.72% return driven by rising iron ore prices and growth in profits. REITs emerged as the next-best performer, delivering 13.54% return for the quarter as bond yields plummeted globally. Banks were one of the poorest performers of the quarter, returning only returned 2% as falling bond yields and a falling housing market impacted on prospects.
The Australian yield curve flattened with the spread between long-term rates and short-term rates narrowing during the month of March (-8.5bp). The Australian 3-year bond yield fell -24.3bp to 1.39%, while the 10-year bond yield fell -32.8bp to 1.78%. The US curve flattened with the spread between long-term rates and short-term rates narrowing during the month (-5.6bp). The US 2-year bond yield fell -25.4bp to 2.26%, while the 10-year bond yield fell -31.00bp to 2.41%.
Metals were flat in March. Zinc (+6.6%) recorded the largest monthly increase, followed by Aluminium (+0.2%). Lead fell 6.7% during the month as did Tin (- 1.4%), Copper (-1.1%) and Nickel (-0.6%). Brent and WTI rose amid supply tightness. The former was up 1.9% to US$67.58/bbl while the latter increased 4.4% to US$60.14/bbl. Iron ore prices rose +2.8% to end the month at US$ 86.90/t. Gold fell 1.6% to $1292/oz amid strength in the US dollar.
The RBA left rates unchanged at 1.5% in March, as expected. There was nothing particularly significant in the Statement and forward guidance was unchanged.
Australian retail sales were up a modest 0.1%m/m in January, a better performance than in the prior month (- 0.4%m/m). Department store sales were particularly weak again (-2.1%m/m), having been soft in December as well (-1.3%m/m). Clothing and footwear sales were also off slightly (-0.3%m/m).
Employment grew by a modest 4.6K, with some payback in full-time employment (-7K) after a very strong January. Part-time work was up 12K. The unemployment rate edged down to 4.95% while the participation rate ticked down 0.1%-pt to 65.6%.
Australia’s trade balance reported a surplus of A$4.5 billion in January. Headline export growth (+5%m/m) and import growth (+3%m/m) were both strong. The surge in January’s trade surplus was mostly the result of a rebound in non-monetary gold exports. January building approvals numbers delivered an expected stabilisation, with relatively balanced outcomes in detached dwellings (+1.9%m/m) and higher density work (+2.5%m/m). Approvals are now down 28.6%oya and 37% from the peak. Q4 GDP rose just 0.2% q/q (consensus: +0.3%, previous: +0.3%) and 2.3% y/y, with 2H-18 annualising at just 0.9%, the worst since the GFC. The GDP was saved by booming public demand (+1.4%, +6.2% y/y), which is almost the fastest pace since the GFC, adding 1.4% pts y/y to GDP. Worryingly, private demand was flat again, as consumption dropped to a ~6-year low (+0.4% q/q, +2.0% y/y). Nominal GDP edged up (1.2%, 5.5% y/y), driven by the terms of trade (3.1%, 6.0%) lifting company profits (2.4%, 7.7%).
Australian private sector credit growth printed at 0.3%m/m in February. The composition of housing credit was little changed, as loan demand from owner-occupiers (+0.4%m/m) continues to outpace investors (0%m/m).
Chinese Premier Li Keqiang delivered the government work report at the National People’s Congress (NPC) on 5 March, where the Chinese Government lowered their growth target to a range of 6.0-6.5%, from the “around 6.5%” target last year. The February trade report showed significant negative payback. Exports (in US$ terms) came in lower than expected, falling 20.7% oya while imports also slowed in February, falling 5.2% oya. By region, imports from the US recovered in the first two months, rising 4.0% m/m sa in February while imports from Australia fell 3.3% m/m sa.
In the US, a large majority of FOMC participants now expect zero hikes this year, down from a median projection of two hikes in December. Forward guidance was unchanged; the “Committee will be patient” in assessing the outlook, and the reference to rate “adjustments” continues to indicate no bias to tighten or ease.
Over the last quarter the consensus view for global GDP growth has been moderated slightly for 2019, from 3.0% to 2.5% p.a. It sits at 2.5% p.a. for 2020 and 2.3% thereafter. Australia is expected to grow above that, at 2.6% for FY2019 and 2.5% for FY2020. Much of that depends on China.
Despite the fall in global bond yields in March, financial conditions are still tightening. Quantitative easing is now quantitative tightening. For the first time since 2008, global central bank asset purchases are likely to be negative in 2019. Net asset purchases have fallen to zero after running ~$23bn per month in H2 2018 (down from a peak of $160bn in 2016). Purchases are now likely to turn negative in 2019 for the first time since 2008. Policy remains highly divergent. Fed balance sheet reduction began gradually but accelerated over the course of 2018. In contrast, the ECB only stopped net purchases in December, and has promised to initially reinvest fully.
The global economy in 2019 seems to be sending conflicting signals. On the one hand, real domestic economic data continues to look robust, supporting consumption and investment. On the other, financial indicators seem to be flashing red. Real domestic economic data, especially labour markets, look robust. Unemployment is still falling, labour force participation is nearing long-term highs and labour shortages seem to be feeding through into earnings growth. Strong domestic labour markets are driving strong consumption and investment performance. However, financial indicators appear increasingly weak. Equity market volatility remains elevated after spiking over the new year, and yield curves are flirting with implying a recession (at least on a 3M-10Y basis, even if economic performance remains strong).
The Australian economy has performed well even though consumption has slowed. The resource companies had a stellar quarter as prices and volumes increased. China has been and will continue to be the key for our economy for the near and medium term. Iron ore has been a saviour for the economy, especially in the last six months. Iron ore prices began to rise last December due to the reduction in supply from Vale (as a result of the dam failure), while China has begun stimulating demand for iron ore by stimulating growth in its construction sector. This will likely continue for the near term and be a big driver for our economy over the next few months. We are positive on iron ore in the short term, although in the long term we see challenges in the Chinese economy. Any missteps in fixed asset formation will have a significant impact on our economy through demand for resources.
Housing will continue to be a drag on the economy for at least the next 12 months. Approvals continue to fall. Credit availability remains an issue as regulators and bank management focus in on lending standards in the wake of the Royal Commission. The consumer is highly leveraged. The heady days of housing and credit growth are well and truly over. Value is starting to emerge, but we believe that there is more pain to come.
As investors, we must now contemplate the potential for a new ruling party as we enter the election cycle. Recent polls suggest that Labor will win the next election. Policies relating to franking, capital gains, health care, energy and housing, if implemented, will more than likely have an adverse impact on market returns. We should remain cautious with this as the backdrop but also be on the look-out for opportunities that may present themselves in this environment. The large hike in tax will dampen demand across the economy in our view.
We have seen the market rally strongly over the last three months as bond yields hit a record low. In particular, REITS hit pricing levels that are just not justified. It is unlikely we will see this repeated for the rest of the year.
Over the medium to long term we will be looking for quality businesses at reasonable prices. By ‘quality’ we mean companies that operate in attractive industries, have above-average returns, strong cash-flows, good prospects for growth, excellent balance sheets and quality management. In addition, we have a preference for companies that are less impacted by government intervention than others. Opportunities will present themselves as the market either over-reacts or under-reacts to government announcements or economic data.
Currently, within our universe we have a preference for companies with good offshore exposure and that are less impacted by rising bond yields (utilities and infrastructure).
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