October 31, 2019
October 31, 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 market sentiment recovers from August jitters. The S&P 500 hits record highs late in October.
- The US and China agree on a partial trade deal. China agrees to buy more agricultural goods while the US suspends tariff increases planned for October. The deal is limited in scope however the de-escalation in tensions is a promising development.
- The pound surges as the UK government and EU agree on a revised withdrawal agreement substantially reducing the risk of a hard Brexit. Obstacles remain passing the legislation through the UK parliament.
- Eurozone business surveys confirm weak growth, but with some hints of stabilisation.
- The RBA cuts local rates to 0.75% noting the trend to lower interest rates around the world.
The provision of more central bank liquidity and the reduction of significant tail risks in recent months has lifted market sentiment. The thawing in trade tensions between the US and China and diminished hard Brexit probability are both relevant to Europe in particular. The upshot is that European equities are up around 20% so far this year, recently surpassing levels reached in January 2018. The S&P 500 has made similar gains year to date. However, for these gains to be sustained into 2020, macroeconomic risks are also likely to have to diminish, with a substantial improvement in economic data and business sentiment needed.
USA: The S&P500 reached all time highs late in October, fueled by signals of progress in US-China trade talks and the latest batch of corporate earnings. The earnings season is in full swing with more than 40% of companies having reported their numbers so far. The average earnings surprise currently stands at 4.4%, slightly above average, which results in overall earnings falling by 0.5% compared to the same time last year. The fact that the market is at record highs despite negative earnings growth shows that the weakness was expected. However, a gap has opened in regard to future earnings growth where consensus expects a solid rebound beginning in the current quarter while economic data still point to a continuation of the challenging environment. Although Markit’s Manufacturing and Service PMIs stabilised in October, the Composite index ticked up to just 51.2 and remains dangerously close to multiyear lows.
China: Data released for July and August confirmed a rapid slowdown in economic growth. Pleasingly, September activity and lending data show signs of stabilization, but not yet strong enough to reverse the weakness of previous months. September industrial production was resilient at 5.8% year on year (YoY), led by a strong rebound in mining activities. Fixed investment grew by 5.4% year to date, roughly in line with August figures. Retail sales also ticked up from 7.5% to 7.8% YoY. While some effects of monetary easing seem to be reflected in stronger credit data, more stimulus is likely required given that uncertainties around US-China trade still prevail despite positive developments from the last round of trade talks.
Europe: The risk of a no-deal Brexit has fallen dramatically after the UK and EU agreed on a revised withdrawal agreement. While the British parliament supports the withdrawal deal in principle, it did reject the tight timetable with Brexit now pushed out to 31 January 2020.
There has been further positive news given tentative signs of stabilization in some of the Eurozone manufacturing PMI survey indicators such as new orders and inventories in the second half of October. The ECB bank lending survey also showed a net easing in lending standards to enterprises in Q3 after tightening in Q2. However, the detail of the Eurozone PMI survey revealed a further weakening in hiring intentions in both services and manufacturing, and the overall composite PMI is still consistent with very weak growth.
Despite robust improvement in the manufacturing PMIs and the housing sector, business and consumer sentiment deteriorated in September, prolonging the downtrend since mid-2018. While the surge in iron ore exports has provided support to growth, it seems to have run out of steam amid a downward correction in global iron ore prices and deterioration in China’s steel demand. That said, public spending, which has been the biggest contributor to GDP growth so far this year, will continue to be the main engine for the economy going forward.
Australian equities continue to outpace most global counterparts year to date and have performed particularly well since the federal election. The sharp shift to value in September seen in global markets was also evident in Australia, with financials and materials generally performing well. In the smaller end of the market, specialist retailers Baby Bunting and City Chic posted strong returns over the quarter after reporting strong FY19 results with revenue and earnings growth significantly above the sector average. In a market where valuations are arguable stretched, both companies offer structural growth for the next few years and the potential for further share price appreciation.
Cash and Fixed Interest
Positive news on US-China trade and Brexit negotiations fueled a spike higher in bond yields. In Europe, reports of dissent around the relaunch of the ECB’s QE program also contributed to a move higher in yields. Credit spreads continue to remain firm. The supply/ demand technical remains supportive in credit, with strong inflows recorded in most parts of the credit market, driven by a search for yield and accommodative monetary policy.
Global growth remains weak and central bank actions have failed to move inflation expectations higher, with further easing measures likely. While yields could rise further on positive news on geopolitics they appear capped given the outlook for growth and inflation.
Property – AREITs
The AREIT market posted a total return of +1.1% in the September quarter, underperforming the broader market despite the 10 year bond rate falling by 30bps. The AREIT market reached somewhat of a natural ceiling, having performed very strongly in the past couple of years and several large stocks reaching very high stock prices. Dexus underperformed with the market becoming more concerned about lower demand in the Sydney office market and increasing supply in the Melbourne office market. Conversely, mall stocks Unibail, Scentre and Vicinity found some support given their relatively attractive pricing. Goodman Group also underperformed in the September quarter due its removal from the EPRA/NAREIT global REIT Index and the demonstrations occurring in Hong Kong, one of its key growth markets.
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, Celeste Funds Management, Bloomberg.
Important information: The content of this publication are the opinions of the writer and is intended as general information only which does not take into account the personal investment objectives, financial situation or needs of any person. It is dated October 2019, is given in good faith and is derived from sources believed to be accurate as at this date, which may be subject to change. It should not be considered to be a comprehensive statement on any matter and should not be relied on as such. Past performance is not a reliable indicator of future performance and should be used as a general guide only. Neither Zurich Australia Limited ABN 92 000 010 195 AFSL 232510, nor Zurich Investment Management Limited ABN 56 063 278 400 AFSL 232511 of 5 Blue Street North Sydney NSW 2060, nor any of its related entities, employees or directors (Zurich) give any warranty of reliability or accuracy nor accept any responsibility arising in any way including by reason of negligence for errors and omissions. Zurich recommends investors seek advice from appropriately qualified financial advisers. Zurich and its related entities receive remuneration such as fees, charges and premiums for the financial products which they issue. Details of these payments can be found in the relevant fund Product Disclosure Statement. No part of this document may be reproduced without prior written permission from Zurich.
Past performance is not reliable indicator of future performance. GINN XYY9MQ.00000.SP.03. PNOE-015021-2019