Investment update - March 2019

MARKET UPDATE

Sustained optimism about Sino-US trade tensions and indications that the US Federal Reserve will not raise rates over 2019 both pushed global equities to their strongest quarter in nearly a decade, after the volatile end to 2018. 

The MSCI World (ex-Australia) Index returned 12.6% over the March quarter on an AUD-hedged basis, and was followed closely by other equity markets.

Volatility also continued to fall, with the VIX Index, which measures implied US equities market volatility, falling below 13% mid-March; the lowest since September 2018.

Locally, the S&P/ASX 200 Index climbed to a close of 6,285 at the start of April; the highest level since September 2018. A softening in RBA policy outlook helped buoy the domestic equity market.

Narrowing credit spreads and reduced inflation expectations helped fixed interest, with the Australian and overseas markets returning 3.4% and 2.8% for the quarter, respectively. Both corporate and government bonds benefitted from central bank signalling. 

After oscillating between 2.5% to 2.9% throughout 2018, 10-year Commonwealth Government bond yields plummeted to a record-low of 1.73% in late March. In the US, yields similarly fell, albeit only to a one-year low of 2.37%. While the decline in yields has a positive impact on price performance of bonds, the flattening of the US yield curve was taken less positively by the market. 

The current spread between 3-month and 10-year bonds fell to 10 basis points by early April, while the 3-month versus 5-year spread inverted to around minus 10 basis points. An inverted yield curve is interpreted as a harbinger (although by no means a certain one) of impending economic recession.

Despite the positive quarter for global markets, the economic outlook for 2019 has become increasingly muted. The IMF published revised GDP growth forecasts in early April, cutting the global figure by 0.2% to 3.3%. Forecasts were cut across developed economies, although Germany and Italy were the most pronounced among major economies, both having GDP growth forecasts for 2019 cut by 0.5%. Australia fared even worse, with its GDP growth forecast for 2019 cut by 0.7% to 2.1%.

Australia

The Australian economy continued to record mixed data, with GDP growth for the fourth quarter of 2018 coming in at a disappointing 0.2% quarter-on-quarter and 2.3% year-on-year; the latter figure well below government and Reserve Bank of Australia (RBA) forecasts of around 3.0% made earlier in 2018.

More tellingly, the annual GDP print masked two key points – firstly, that annualised growth has fallen from 4% over the first half of 2018 to just 1% in the second half. Secondly, on a per capita basis (that is, excluding the positive impact of population growth), the economy actually contracted two quarters in a row, putting the economy in a ‘per capita’ recession.

The federal budget was announced a month earlier than usual due to the general election that has now been confirmed for 18 May. The budget provided ample stimulus measures including income tax cuts (albeit deferred to the mid-2020s) and infrastructure expenditure in an attempt to improve the coalition’s election polling. The budget also forecast a return to surplus for the first time in 11 years.

Despite the government’s favourable fiscal picture, its projected surpluses remain predicated on somewhat ambitious economic forecasts, especially compared to the IMF’s latest revisions. A key factor driving down economic growth forecasts is the continued weakness in the housing sector, with prices across the five major capital cities falling by 8.6% year-on-year.

The weakening housing market led the RBA to shift toward a softening rates outlook, with markets now expecting the next RBA interest rate movement to be down rather than up, with a 25 basis point rate cut considered likely by July 2019, and a further cut by mid-2020 which would take the cash rate to 1.00%.

United States

The US economy seemed to turn a corner following the dovish tilt by the Federal Reserve in January, with data generally improving relative to previous months. Fourth quarter GDP came in at an above-expected annual rate of 2.6%.

In March the Federal Reserve announced a plan to end its current balance sheet reduction program in September this year, and also indicated it will not increase its target rate any time this year. The dovish tilt helped push up US equities, which had their best quarter since 2009 and their best three-month start to a calendar year since 1998.

On the political front, Robert Mueller’s much-anticipated report was finally released in mid-March, finding no evidence that President Trump’s team colluded with the Russian government in the lead-up to the 2016 presidential election. The result did little to shift Trump’s approval rating but will no doubt come as a huge relief for the President.

Europe

The Eurozone economy continued to stutter, with fourth quarter GDP growth revised downwards to an annual rate of 1.1%. European Central Bank (ECB) core and headline inflation forecasts were both revised downwards for 2019 to 1.2%, and forecast GDP was cut to 1.1%. In tandem with the downward revisions, the ECB announced a new policy measure to be implemented in September of this year. 

The recommencement of ‘Targeted Longer Term Refinancing Operations’ (TLTROs), first issued in 2016 and 2017, are intended to replace the earlier issuances as they approach maturity, and to encourage banks to on-lend to the private sector at low rates.

Sentiment indicators deteriorated over the quarter across Europe, especially for manufacturing. The IHS/Markit Composite PMI reading for Germany, the region’s largest economy, hit a nearly 6-year low in March. More worryingly, German manufacturing PMI was the worst among the eight surveyed Eurozone nations, reaching an 80-month low of 44.1. Despite the gloomy outlook, employment data remains positive, with Euro area unemployment holding steady at a 10-year low of 7.8%.

As with the Federal Reserve, the ECB suggested a cautious approach to policy settings over 2019, reiterating that while rates are expected to remain unchanged, tail risk is skewed to the downside.

United Kingdom

The original Brexit deadline of 29 March came and went with the UK remaining part of the EU for now, with an extension to the end of October 2019 granted by the European Commission, with a review in June. The extension means the UK will participate in European Parliament elections in late May despite likely bowing out of the Parliament just several months later. The extension was granted after repeated failure by Prime Minister Theresa May to gain a parliamentary majority in support for her Brexit plan, even at one stage offering her resignation as a sweetener to garner votes.

Brexit uncertainty failed to dampen economic data. GDP beat forecasts to increase by 0.2% in February, with manufacturing soaring 0.9%, ironically driven by firms increasing output and stockpiling inventories ahead of Brexit. The unemployment rate edged lower to 3.9%; the lowest in 44 years, while the participation rate reached an equal record high of 76.1%. Strong employment data helped drive wage growth to an annual 3.4%. Meanwhile, the annual inflation rate increased 0.1% to 1.9% for February, with food, alcohol and tobacco, and recreational goods the main drivers.

China

Ongoing negotiations between China and the US continued into April, however consensus expectations are of an amicable resolution, eventually.

The increased optimism helped Chinese economic data, with exports increasing by 14.2% for March compared to a year earlier after a steep decline in February, while Chinese equities hit a one-year high in early April.

Despite the increased optimism, the Chinese government revised its 2019 GDP growth forecasts downwards from the 6.5% target to a range of 6.0% to 6.5%, while manufacturing sentiment gauges were increasingly contractionary.

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