Investment update - June 2018

The June quarter was primarily noteworthy for increased policy tightening in both the United States and in the eurozone, as well as an escalation of trade war tensions between the US and China. Geopolitical manoeuvring also attracted attention, particularly with the historic summit between President Trump and North Korean leader Kim Jong-un in Singapore in June.

Positive economic news ultimately trumped geopolitical concerns for developed market equities over the June quarter. The continued global economic recovery saw overseas developed market equities return 5.5% on an unhedged basis and 3.6% on a hedged basis, while Australian equities returned 8.4%. After a very volatile start to the year, the volatility in equity markets dissipated over the June quarter. In terms of commodities, cuts in production and geopolitical concerns in the Middle East drove up the price of oil, with Brent Crude momentarily breaching US$80 per barrel in late June, a considerable increase on just under US$50 per barrel a year ago.
Political uncertainty in Italy had a profound but short-lived impact on fixed income markets, leading Italian 10-year government bond yields to soar from 1.8% to almost 3.2% (meaning bond prices fell) as investors sold off securities in the world’s fourth-largest debt market in exchange for safer German, British and US government debt. The political uncertainty and the corresponding increase in yields contributed to a poor quarter for fixed income broadly, with overseas fixed interest returning just 0.2% for the quarter. Australian fixed interest held up by comparison however, returning 0.8%.

Australia

Australia’s first quarter GDP growth, released in May, came in at a seasonally adjusted 1.0%, putting annual growth at an above-expected 3.1%. The result was primarily due to a strengthening global economy and, in turn, a healthy foreign appetite for Australian resources. Employment data continued to impress, with the nation’s unemployment rate falling 0.2% in May to a half-year low of 5.4% on a seasonally-adjusted basis. While 12,000 jobs were added over the month, the fall in unemployment was also attributable to fewer people seeking work, with the participation rate falling 0.2% to 65.5%.

The nation’s property market has continued to experience price declines. In Sydney, prices fell by over 4.5% in the year to 30 June, which is the worst annual performance since the global financial crisis. The fall in prices has been attributed to tightening lending standards and weaker investment demand. The Melbourne market also posted a weak (albeit marginally positive) annual return. Dwelling prices in the five large capital cities fell by an aggregate 1.7% over the year, according to CoreLogic’s hedonic index.

As was widely expected, the Reserve Bank of Australia kept rates unchanged yet again at its early July meeting, representing 21 straight meetings and 23 months without a change. Monetary policy tightening remains highly unlikely over the near term, with the market not expecting a rate hike until late 2019.

United States

The US economy continues to post robust economic data, with inflation growing at its fastest pace since 2012. Additionally, wage growth climbed to 2.7% year-on-year as the unemployment rate fell to an 18-year low of 3.8% in May. It was against this backdrop that the US Federal Reserve agreed to hike its target rate by 25 basis points at its June meeting, pushing the range up to 1.75-2.00%. The committee’s assessment of the economy was upbeat, with its rate expectations now leaning increasingly towards four hikes over the calendar year. Market participants, however, remain evenly split as to whether there will be three or four hikes in 2018 (so, one or two additional cuts before year-end).

President Trump’s political posturing continued to impact markets. His landmark summit with North Korea leader Kim Jong-un in June was the first between leaders of the two nations. It resulted in North Korea making a vague promise to denuclearise in exchange for the United States eventually removing its military presence from the Korean peninsula. At the G7 summit a week earlier, President Trump had attracted the ire of allies by both calling for the readmission of Russia to the group and indicating the imminent imposition of tariffs on the EU, Canada and Mexico. Trump followed this up with the announcement of tariffs on a number of Chinese imports.

Europe

After a stellar 2017, the European economy started to show signs of slowing down slightly, with first quarter GDP growth disappointing in April. The figure came in at 0.4% for the quarter, down from 0.7% for the preceding quarter and the worst three months since mid-2016. Unseasonably cold weather and industrial action in France were both factors for the poor print. May eurozone inflation soared 0.7% to 1.9% year-on-year, in part because of the price of oil surging to over US$80 per barrel. Meanwhile, the eurozone’s unemployment rate continues to fall, reaching 8.4% in May, which is the lowest the rate has been in nearly a decade.

The European Central Bank made a surprise decision on 14 June, announcing it will end its asset purchase program by the end of 2018. With the current extension of €30 billion per month scheduled to end in September, the ECB announced a halving of monthly purchases through to December, with no further purchases thereafter. The decision reflects the central bank’s view that the eurozone economy is sufficiently robust to withstand an increase in bond yields (and therefore borrowing costs). It did, however, indicate that the deposit rate will remain at -0.4% until at least mid-2019.

Economic data continues to be mixed for the United Kingdom. The first quarter GDP print of just 0.1% growth put annual growth at 1.2%; the weakest rate since 2013. Major factors responsible for the result were the broader global economic uncertainty amid fears of a trade war, inflationary concerns and an uncharacteristically severe winter.

China

The Chinese economy recorded annual GDP growth of 6.8% to the end of March 2018. The figure was above the government’s target of 6.5% and was above market expectations given the increased push from President Xi Jinping to focus on improving quality of life (for example, by tightening pollution controls) and reining in excess debt growth.

Negotiations with the US failed to avert the possibility of an all-out trade war. Three rounds of talks throughout May and early June between the two global powers ended without any agreement. So far, several rounds of tariffs have been announced and implemented by both the United States and China on a wide variety of imports. President Trump has threatened that the tariffs against China could total around US$550 billion in Chinese imports, which is the approximate volume of the total amount of Chinese imports into the US in 2017. In other words, all Chinese imports into the US could face a tariff of some size.

You can download the full report here.