Russell quarterly update
June quarter 2018 // Market commentary
Here’s a summary of investment markets for the three months ending 30 June 2018
Global share markets stronger
Global share markets made good gains in the second quarter, benefiting in part from yet another round of positive US earnings results, including major technology names like Netflix, Facebook, Amazon and Google parent, Alphabet. Other companies to post stronger earnings were Boeing, Walt Disney and Macy’s. Stocks also benefited from improving US jobs data, stronger commodity prices and some encouraging Chinese economic growth; the world’s second-biggest economy expanding 6.8% in the first quarter. Sentiment was further buoyed by easing political uncertainty in Italy and news the European Central Bank expects to leave interest rates on hold until at least midway through next year. Limiting the advance were a series of geopolitical risks, including an escalation in US-China trade tensions, Donald Trump’s decision to quit an international deal with Iran aimed at preventing the country from acquiring nuclear weapons, and a disappointing end to the G7 Summit in Canada. Stocks were further impacted by the US Federal Reserve (Fed)’s decision in June to accelerate its rate hike agenda and some softer-than-expected Japanese growth data; the latter’s economy contracting 0.2% in the March quarter and ending a run of eight consecutive quarters of expansion.
At the country level, share markets in the UK, Japan, the US and Europe were all higher for the quarter, while Chinese stocks struggled amid ongoing trade tensions with the US.
Australian shares were also stronger for the quarter; the local market benefiting from some positive earnings updates from the likes of Qantas, Macquarie Group and CSL Ltd., and stronger commodity prices; the latter helping to propel our major miners sharply higher over the period. Stocks also benefited from further domestic corporate activity, including takeover bids for both Healthscope and Investa Office Fund, and further Chinese growth. Limiting the advance was further fallout from the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, the Fed’s decision to accelerate its rate hike agenda and an escalation in US-China trade tensions.
RBA leaves interest rates on hold
The Reserve Bank of Australia (RBA) left the official cash rate unchanged at a record low 1.50% throughout the period. In its latest post-meeting statement, the central bank said it expects growth to average a bit above 3.0% this year and next, employment growth to continue to improve and inflation, which remains below the RBA’s 2-3% target range, to stay low for some time; though a gradual pick-up in inflation is expected as the economy strengthens. Meanwhile, officials acknowledged wage growth remains low and that a stronger Australian dollar (AUD) would be expected to result in a slower pick-up in economic activity and inflation than is currently forecast. Household consumption is also a concern, with household incomes growing slowly while debt levels remain high. The RBA concluded its latest meeting by saying that “taking account of the available information, the Board judged that holding the stance of monetary policy unchanged… would be consistent with sustainable growth in the economy and achieving the inflation target over time.”
Recent softer wages and inflation data, falling house prices and a moderation of RBA language have seen market expectations for any Australian rate hike in 2018 evaporate. However, we note that the US Federal Reserve is still in a clear tightening phase and that inflation is strengthening once again around the world. We believe the RBA’s next move will be a rate rise.
Domestic economy expands
The Australian economy expanded by more than expected in the first quarter of 2018 with gross domestic product (GDP) for the three months ended 31 March coming in at 1.0%. Most economists had anticipated growth of 0.9%. Rising exports accounted for half the growth in GDP while government spending and household consumption also contributed positively to the outcome. On an annual basis, the economy grew 3.1%; up significantly on the 2.4% growth recorded in the 12 months ended 31 December 2017.
Australian dollar rises
The AUD made modest gains in the June quarter; the local unit benefiting from another round of broadly positive earnings updates, further encouraging Chinese growth figures and stronger commodity prices, including oil, nickel and aluminium. Limiting the currency’s advance were rising US interest rates, heightened geopolitical uncertainty and expectations still-soft inflation and wages data will force the RBA to leave interest rates on hold for longer. The AUD was also impacted by a further widening in the yield differential between US and Australian government debt.
The AUD rose 3.5% against the British pound, 2.0% against the euro and 0.3% against the Japanese yen. It fell 3.6% against the US dollar (USD), while the broader Australian Trade-Weighted Index[1] closed the quarter 0.5% higher.
Looking ahead
We expect volatility to continue through 2018 as investors contend with US policy agenda, potential further US rate hikes, potential normalisation of monetary policy outside the US and ever-present geopolitical risks.
Relative to the US, we still believe other developed markets represent better value. Despite the slowdown in early 2018, we remain upbeat on the health of European economies; though caution is warranted given rising near-term political risks. Emerging markets assets have weakened recently from a stronger USD, but corporate earnings and economic growth are still resilient. In saying that, geopolitical risks remain along with the threat of tighter US monetary policy and a potential trade war between the US and China. We still believe emerging markets represent superior value relative to their developed peers on a longer time horizon.
Our base case is for the Fed to raise interest rates a total of three to four times in 2018. We feel bonds remain expensive and may face headwinds in the form of potential rising inflation and higher US yields, especially given that the US labour market is tight. Any selloff in bonds could be amplified if the Fed decides to raise rates at a faster pace than expected, and if global central banks shift away from their accommodative monetary policy stances. We hold an unfavourable view on high-yield debt, as valuations have become stretched given the compression in credit spreads to near-historical lows. Conversely, we favour local currency emerging markets debt, with fundamentals remaining strong.
In terms of currencies, the USD has staged a recovery, driven by interest rate differentials between the US and the rest of the G10. We hold a neutral view on the USD, and believe its recent rebound is technical rather than structural in nature. We continue to hold a preference for the Japanese yen, given the solid economic data flow from Japan, including strong external demand and a tightening labour market. The yen is also attractive from a ‘safe haven’ perspective, as it is the currency most negatively correlated with global equity returns. Meanwhile, the future direction of the AUD is likely to continue to be influenced by movements in commodity prices together with any potential shift in the RBA’s stance on monetary policy.
Overall, we expect global growth to remain modestly positive through 2018, with downside risks of further market selloffs as markets continue to adjust to potentially higher levels of interest rates and changes to monetary and fiscal policy, especially in the US. Importantly, though, we believe financial markets will continue to provide further investment opportunities for our active management approach.
[1] The trade-weighted index for the AUD is an indicator of movements in the average value of the AUD against the currencies of our trading partners.