Investment update - June 2019

After some tremors around trade war uncertainty and central bank policy in May, June saw renewed optimism across global markets. Sino-US trade talks are set to recommence and central banks across the globe have signalled further policy support.

The sustained dovish tilt by central banks was a boon for equities markets, which had a stellar quarter. Australian equities returned 8.1% on a price return basis for the three months to the end of June. The RBA’s rate cuts in June and July were a key driver for the returns, with the S&P/ASX 200 Index breaching 6,750 in early July for the first time since November 2007 – a level it has only closed above five times in its history, and less than 75 points from its all-time high closing price.

The leading US index, the S&P 500, reached a new record high on a price return basis in late June before nearing the passing the 3,000 mark in early July.

Fixed interest performance was similarly strong, helped by expectations of ongoing low inflation and central bank support. As a result, the US 10-year Treasury yield fell below 2.0% (after being above 3.2% just 8 months earlier), while its Australian equivalent fell to a record low of 1.3%.

Australia
In Australia, monetary policy remained at the forefront of economic news. On 2 July, the Reserve Bank of Australia met consensus forecasts and cut rates by 25 basis points for the second straight month. The cut takes the official cash rate down to a record low of 1.00%, with markets pricing in another cut by year-end. The impetus for its dovish tilt has been to reduce labour market slack – despite the unemployment rate sitting at 5.1%, with the RBA seeing a lower rate needed to maintain inflation expectations.

Australian households also received a fiscal policy boost, with the re-elected Coalition government passing income tax changes that will boost household incomes. The combination of fiscal and monetary policy is likely to help the country’s struggling housing sector, with prices in June stabilising in the major markets of Sydney and Melbourne. Nonetheless, household sentiment has deteriorated, with increasing concerns about individual finances.

The nation’s trade surplus continued to widen, climbing to a fresh record high of $5.7bn. The result was driven by strong export performance, propelled by higher commodities prices and robust foreign demand. As a result of successive monthly trade surpluses since early 2018, the current account deficit has now narrowed to 0.6% of GDP for the March quarter; the third highest on record and the lowest in just under 40 years.

United States
In the US, trade tensions again dominated economic headlines – although news over June was somewhat more positive. President Trump decided against pursuing previously-threatened tariffs against Mexican imports following Mexican government assurance around tighter illegal immigration controls. The president also agreed to resume trade talks with China following the G20 summit in Japan. In the process President Trump agreed to indefinitely postpone new 20% tariffs on US$300 billion of Chinese imports and to relax constraints on Huawei’s US operations. In exchange, Chinese leader Xi Jinping reportedly agreed to increased purchase of US goods.

In a further major diplomatic moment, President Trump met North Korean leader Kim Jong-Un at the border with South Korea, in the process becoming the first sitting US president to enter North Korea - albeit venturing only a few metres into the hermit state.

As with other economies, US monetary policy has taken a dovish tilt. Amid weak inflation readings and despite unemployment sitting at a very healthy 3.7%, the Federal Reserve’s Open Markets Committee is expected to cut rates by 25 basis points at its end-July meeting.

Europe
The European Union had a significant trade development, striking a deal with South American trading bloc Mercosur to eliminate tariffs between the two blocs on most goods. The deal was twenty years in the making and hailed by EU Commission chief Jean-Claude Juncker as the EU’s largest to date. It follows on from trade deals the EU has struck with Japan, Mexico and Canada in recent years.

In other European economic news, European Central Bank President Mario Draghi continued to present a dovish tone on future policy, an approach expected to be maintained further supported by his newly announced successor, current IMF head Christine Lagarde. The market response to the appointment of Lagarde, who commences in her role at the end of October, was positive, helping push up equities and bond prices. Germany bund yields reached record lows, with the 10-year yield falling under -0.4% in early July; 2 year bunds, meanwhile, fell below -0.7%.

Meanwhile, Eurozone employment data proved healthy, inflation remained subdued, and sentiment indicators diverged between services PMI (expansionary) and manufacturing PMI (increasingly contractionary).

United Kingdom
In the UK, Boris Johnson firmed as favourite to succeed Theresa May as Prime Minister when the Conservative Party votes on its next leader on 22 July. May resigned after being unable to corral sufficient support from her Conservative Party colleagues for her moderate Brexit plan. Johnson is by contrast considered more of a hard-Brexiteer, increasing the possibility of a no-deal Brexit.

Unemployment reached a 45-year low of 3.8% during the quarter, although other data – such as weaker retail sales growth and declining consumer confidence – was more muted. Inflation, meanwhile, fell to 2.0, with core inflation falling to a 2.5-year low of 1.7%.

China
While trade tensions with the US continued into July, expectations of an amicable resolution between the two economic powers increased. The leaders of the two nations met as part of the G20 summit in Osaka in late June, with an agreement struck to resume talks after a six-week impasse.

Chinese equities benefitted from central bank support, with the People’s Bank of China injecting US$108 billion to maintain liquidity. Coupled with optimism on trade talks with the US, Chinese equities returned 2.8% in June, reversing ground lost earlier in the quarter. While Chinese equities have returned -3.6% for the quarter in local currency terms, their performance in 2019 thus far has been +19.4%; a far cry from the -24.6% capital return in 2018, when trade uncertainty was at its zenith.

Soft data indicators had a relatively mixed month. The unofficial Caixin-Markit manufacturing PMI print fell to a five-month low of 49.4 as international sales and new business contracted, while the official government gauge held steady – also at 49.4. The unofficial services PMI gauge also fell, although remained at an expansionary 52, with state policies – such as tax cuts – considered supportive.

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