Investment Update - September 2019

The September quarter saw equities markets ebb and flow as Sino-US trade tensions, Brexit uncertainty and anti-Chinese government protests in Hong Kong persisted. Overall, data tended to suggest an increasingly pessimistic outlook on the global economy, with sentiment indicators in key economies deteriorating and central banks announcing fresh policy stimulus.

Among asset classes, unhedged developed overseas equities were the best performers for the quarter, returning 4.7% thanks to a weaker Australian dollar as further rate cuts by the Reserve Bank of Australia became increasingly likely. However, increasing uncertainty, a dovish central bank tilt and a continuing tepid inflationary outlook all provided tailwinds for fixed interest, with both Australian and overseas fixed interest having a relatively strong quarter. Indeed, the fall in yields has boosted bond prices to such an extent over the past 12 months that annual returns for Australian and overseas fixed interest composite indices are now 11.1% and 9.8%, respectively; returns comparable to rallying equity markets.

Geopolitical tensions and a weakening economic backdrop saw a spike in equities markets volatility over the quarter. The VIX Index, which measures forecast US equities volatility, reached its highest level since January in early August; albeit recovering as the quarter drew to a close. In emerging markets, Argentina attracted headlines for the wrong reasons, with a primary election loss by the market-friendly incumbent President to a populist rival leading to Argentine stocks plummeting 48% in a single day in mid-August; the second-largest single-day drop of any market since 1950.

Australia

In Australia, second quarter GDP and current account data was released in August. The former met expectations to post growth of 1.4% year-on-year; the weakest since the global financial crisis, and meaning GDP per capita has contracted on a year-onyear basis. By contrast, the nation’s current account recorded its first quarterly surplus since 1975, supported by sustained commodities demand and a surge in iron ore prices.

The RBA cut its official cash rate by 25 basis points at the start of July before cutting rates by the same margin again at the start of October, with the official cash rate falling to a record low of 0.75%. A further cut to 0.50% is considered likely in coming months. With centrals banks globally loosening policy, the RBA’s rate cuts are viewed as providing downward pressure on the Australian dollar, thereby assisting the competitiveness of Australian exports. The cuts will also look to further reduce unemployment and improve sentiment indicators. As the RBA’s cash rate nears zero, the possibility of quantitative easing and other unconventional policy measures being introduced has increased considerably.

The RBA rate cuts helped arrest the recent slide in residential property prices in Australia. Prices increased across the five mainland capital cities in each month of the quarter, rising 2.2% overall; the best quarter since June 2017. Annual declines in the two largest markets, Sydney and Melbourne, have now been tempered to 4.8% and 3.9%, respectively.

The Westpac-Melbourne Institute Consumer Sentiment index hit a four-year low in September, while NAB’s Business Confidence and Conditions measures both remained below average. The weak outlook has led to markets pricing a likely further RBA rate cut by year-end.

United States

While US business and consumer sentiment has increasingly faltered in recent months, employment data continues to impress. The unemployment rate fell to 3.5% in September 2019; the lowest since December 1969. Nonetheless, the overall weakening global economic outlook has pushed the US Federal Reserve to cut rates twice during the quarter. The first cut, in July, was considered an ‘insurance’ cut intended to provide added stimulus without definitively ending the current hiking cycle. However, the second cut in September solidified the notion that the US Federal Reserve is commencing a rate cutting cycle. Market pricing currently suggests a likely cut at the end of October, with another probable by January, by which time the target rate will have fallen to 1.25% to 1.50%.

There was a temporary liquidity crisis in US money markets in mid-September. The repo market, through which banks lend to one another on an 3 overnight basis, dried up and briefly propelled the lending rate to 10% before a sizeable injection of liquidity from the Federal Reserve. The shortage of cash was attributed to both more stringent reserve regulations and a reduced cash supply following the recent reduction of the central bank’s balance sheet, while the due date for quarterly corporate tax payments also contributed. The Federal Reserve subsequently announced monthly cash injections to improve liquidity in the repo market. That said, whether the issue was a fleeting glitch or the harbinger of more serious liquidity problems remains to be seen.

In more positive news, US unemployment fell to a 50- year low of 3.5%, while core inflation increased by a healthy annual rate of 2.4%. By contrast, trade tensions continue to impact US manufacturing, with the ISM Manufacturing survey falling to a decade-low 47.8 in September. A deteriorating employment outlook and global trade concerns were cited as key factors behind the result.

President Trump faces increased scrutiny in coming months, with House Democrats announcing an impeachment inquiry following allegations that the President pressured Ukrainian officials to investigate business dealings linked to Democratic Presidential hopeful Joe Biden. That said, with a Republican-majority Senate, removal of Trump from the Presidency remains unlikely.

Europe

On the European continent, manufacturing sentiment remains weak, especially in Germany, with a heightened likelihood of the country entering a recession. Meanwhile, Italian political risk seems to have abated, with the end of the Five Star Movement’s coalition with the right-wing League in early September seeing the latter being replaced with the centre-left, pro-EU and business-friendly Democratic Party.

The ECB announced a cut in its interest rate in September, taking the official reserve rate 10 basis points lower to -0.50%. Additionally, it announced the recommencement of its asset purchase programme after a several month hiatus. The programme will see €20 billion of net asset purchases each month from November 2019. While well below the €60 billion per month of the prior iteration of the programme from 2015 to 2018, there may be a longer timeframe for the latest version, with the ECB stating it will continue the programme as long as is necessary for the Eurozone’s inflation and growth to return to satisfactory levels.

United Kingdom

As the Brexit deadline of 31 October draws closer, newly-appointed Prime Minister Boris Johnson took the drastic action of proroguing British parliament for five weeks to mid-October. The move was intended to constrain Brexit deliberation and force the hand of anti-Brexit MPs. However, Johnson’s move backfired, prompting the resignations or defections of a number of Tories, and with 21 rebel Conservative MPs voting with the opposition to stop a no-deal Brexit and seek a three-month extension should no deal be reached. His party has lost its voting majority in the Commons, and Johnson’s proroguing was determined to be unlawful by British court, meaning parliament recommenced in late September. A Brexit delay now seems the most likely outcome. While Brexit fears pushed sentiment gauges down and inflation has fallen to its lowest level in nearly three years, unemployment remains at a healthy 3.8%.

China

Trade tensions between China and the US continued over the quarter. US President Donald Trump started August by announcing an additional 10% tariff on US$300 billion of Chinese imports from September (albeit later deferring imposition on around half until December), with the Chinese government returning fire with tariffs of 5% to 10% on US$75 billion of US imports. The US also planned to increase tariffs on a further $US250 billion of Chinese imports from 25% to 30% in October. However, the tariffs were postponed to December following trade talks between the two nations in October. In exchange, China agreed to purchase an increased amount of US agricultural produce.

Closer to home for China, tensions continued on the streets of Hong Kong, with local leader Carrie Lam capitulating to the demands of anti-government protestors to drop proposed extradition laws. Nonetheless, the protests continue, with demands now extending to release and exoneration of protestors, Lam’s resignation, and universal suffrage for the Legislative Council and Chief Executive. Concerns continue to grow around how the protests will be defused.

You can download the full report here.