August 29, 2019
August 29, 2019 | Investments Insightz
In this month’s Market Update Patrick Noble, Senior Investment Strategist, looks at the latest events driving investor sentiment across the major asset classes.
- Equity markets retreat from their recent highs as trade tensions between the US and China escalate. For now, brinkmanship appears the preferred course of action as tit-for-tat measures are announced by the US and China.
- The US Federal Reserve cut its target rate by 25 bps to a range of 2% -2.25%. Powell reiterates at Jackson Hole that the Fed will “act as appropriate to maintain the expansion”. President Trump continues to blame the Fed for slowing US growth in a series of withering tweets.
- Economic data remains weak across the globe. Significant stimulus packages are expected from the ECB and potentially China. Inverted yield curves reflect negative sentiment and stoke recessionary fears. Close to one third of global debt is now negative yielding.
- The RBA keeps local rates at 1% while noting “it is reasonable to expect an extended period of low interest rates.”
- In Europe, Boris Johnson’s attempt to renegotiate the terms of Brexit appears to be falling on deaf ears. Italians could be heading to the polls again as the fragile coalition between Lega and Five Star Movement formally breaks down.
Global equity markets have retreated from recent highs buffeted by ongoing trade barbs, USDCNY (Chinese Yuan) currency moves, and slowing economic growth. Most recently, equity markets and bond yields slumped while the CNY depreciated further after China announced additional tariffs on USD 75bn of US goods. This is the third round of retaliation following earlier measures by the US to tighten the screws on China by adding 10% tariffs on USD 300bn of Chinese goods in September and December. President Trump reacted immediately and hastily announced a further drastic hike in tariffs on China imports. He was quoted saying “We don’t need China and frankly, would be far better off without them”, while he ordered US companies to start looking for alternatives to China and urged them to move production back to the US. It is worth noting that China’s retaliation measures are not broad-based, but focus on specific goods like autos, oil and soybeans. These are products that can be sourced from other countries and are believed to increase domestic pressure on Trump from US producers and consumers. Markets will remain turbulent, as angst and relief about the impact of the trade war on the global economy seem to be alternating quickly.
USA: Investors remain torn between growth worries and the further escalation in the US-China trade war versus the hope for more monetary stimulus. Last week a pragmatic sounding Fed Chair offered some good news on the latter at the Jackson Hole Symposium. While not overly dovish, Chair Powell left the door open for another rate cut in September. Certainly, the domestic economy is also showing vulnerability. The Markit manufacturing PMI dipped below 50 in August for the first time since the financial crisis. New export orders fell at the fastest pace since August 2009, underlining the fragile state of the world economy. While services have been holding up relatively well so far, the corresponding business activity index fell to a modest 50.9 and business expectations among service providers were the lowest in almost a decade. Overall, the latest survey points to annualised growth of around 1.5%, a significant slowdown from recent levels.
China: China’s economic data for July came in weaker following the rebound in June and far below consensus expectations. Industrial production fell from 6.3% to only 4.8% year on year (YoY), a record low since statistics started in 1990 (adjusted for Lunar New Year distortions). Export weakness and relocation activities in the auto, machinery and electronic equipment sectors were a major drag. Fixed asset investment growth slowed from 6.3% to 5.2% YoY, driven by weaker property and infrastructure growth particularly by privately owned companies. Land sale volumes plummeted by 36.8% as authorities tightened their grip on property developers. Policy support measures need to accelerate over the next few months and should remain targeted.
Europe: Despite a modest pickup in the Eurozone composite PMI from 51.5 in July to 51.8 in August, downside risks remain high. Indeed, the details of the survey were less encouraging than the headline. Although business activity in the service sector rose modestly, the incoming new business expectations and employment sub-indices were all lower. In manufacturing, there were some signs of stabilisation, but at very weak levels, while the further escalation in global trade tensions last week will do little to help bolster business confidence going forward. Overall, the composite PMI is still consistent with positive growth in the Eurozone, but risks of a further slowdown in activity remain high. The release of the ECB minutes confirmed that it is preparing a package of measures for its meeting on September 12, including cutting interest rates and re-starting QE. While this will probably help investor risk appetite in the short term, unless it is combined with a boost from fiscal policy and a de-escalation in trade tensions, the impact on the real economy is likely to be limited.
Australia’s consumer and business confidence improved modestly following the interest rate and tax cuts in July, while the unemployment rate remained at 5.2%. APRA’s easing of its lending rules has also helped stabilise the local housing market and all combined to push the local share market past its November 2007 highs. The market has since retreated during August given global headwinds and muted earnings guidance from Australian corporates.
Reporting season has provided a mixed bag for investors. Retail stocks such as JB HiFi have performed reasonably well given poor market sentiment towards the sector and the major miners have typically delivered sound numbers supported by high commodity prices. Telstra shares have been weaker following a dividend cut while Boral was severely punished after reporting to the market. Earnings expectations may yet prove too optimistic for FY20 and while fully franked dividends are attractive, valuations remain distorted in some segments of the market.
Cash and Fixed Interest
Bond yields fell to new lows mid-August, with the 30yr Treasury yield below the 2% mark, the 10yr Bund yield at -0.71% and the 10yr Swiss yield at a stunning -1.12%. Close to one third of global debt is now negative yielding. The 10/2yr segment of the US yield curve inverted intraday on 15 August, though it later rebounded and closed slightly above zero, and the gilt and Swiss bond markets saw similar inversions. This is likely to have contributed to negative sentiment towards risk assets, as an inverted curve is considered a good predictor of recession. The latest slide in global yields reflects geopolitical risk, poor macro data and erratic news on the US-China trade war, with a sharp repricing of central bank actions as a result.
The downward adjustment in yields has been significant though and is pricing in a substantial amount of stimulus ahead of the ECB and Fed meetings in September. Unless data worsens significantly, yields may well see some stabilisation in the weeks ahead.
Property – AREITs
In a transaction that demonstrates the improving sentiment towards residential markets, Stockland announced a capital partner for 50% of ‘Aura’, its major housing project in Caloundra on the Sunshine Coast. The new partner acquired its stake in the project at a 30% premium to book value. RBA rate cuts, APRA relaxing its loan serviceability requirements and improved auction clearance rates are good indicators for residential markets. However, housing finance approvals are still well down on last year and although operators are reporting improved enquiry levels this is still to translate into higher volumes of sales. Prices have stabilised but are not yet showing upside with volumes needing to recover first.
While falling bond yields have continued to provide support for AREITs, underlying property values are close to mature-cycle levels. The AREIT market overall appears relatively expensive on a price to Net Asset Value (NAV) basis, albeit significantly bifurcated between sub-sectors that are in vogue, such as office and industrials, and those that are not, particularly retail. Distribution yields remain attractive relative to bonds.
For more information on the markets contact your financial adviser.
Sources: Zurich Insurance Group, Renaissance Asset Management, American Century Investments, Lazard Asset Management, Wells Fargo Asset Management, Bloomberg.
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