Investment commentary August 2015
August saw significant weakness in share markets globally as investors became wary of the potential for Chinese economic growth to slow at a greater rate than previously expected. The selling pressure extended to all major share markets, and saw the level of volatility spike before a partial recovery towards the end of the month.
Against the weaker market, economic indicators outside of China remained relatively unchanged. We continue to suggest that economic growth is continuing at a muted level. But with asset prices such as shares and bonds fully priced, markets are somewhat vulnerable to the type of weakness we saw during August.
Economically there was little significant news in Australia during August. The Reserve Bank of Australia’s (RBA’s) decision to keep rates unchanged was as expected. The Australian economy is seen to be growing modestly, with the rotation from mining activity to services continuing.
The flow-on from China-led volatility negatively impacted Australian shares, with the market returning 7.7% for the month. Prior to the late-month recovery, shares were down over 11% mid-month.
In a historical context, a monthly market fall of this size is significant – our view is that this offers some additional support to the value offered by shares.
Sectors that contributed most to the weakness were Banks and Energy, whereas Consumer-related sectors and Utilities performed better.
On balance, US economic growth held up solidly during August. Due to the recent fall in energy prices and ongoing subdued inflationary pressures, timing estimates for the first rise in interest rates were pushed out. But this changed late in August, with the second-quarter GDP estimates surprising positively at 3.7%, compared to the expected level of 3.2%.
We would be somewhat surprised to see the US Federal Reserve increase rates in September. But the US continues to grow steadily and recent comments from Federal Reserve Governors highlight that they would prefer to be proactive in managing potential future inflationary pressures. US stocks were impacted by the global volatility and were materially lower, however US 10-year Treasury bonds were unchanged for the month.
Post the fireworks experienced in June from the ‘Grexit’ headlines, Europe was relatively quiet until late August when Greek Prime Minister Alexis Tsipras called a snap election for September. The election is an attempt to reassert his leadership, following the unpopularity of the recent debt bail-out package. The early polling has the incumbent Syriza party as the likely winner, an important outcome for near-term Greek stability.
Activity indicators for Europe were broadly in line with expectations, so the direction of European markets was driven by the global weakness. Most European markets were lower by six to nine percent. Interestingly, bond yields for European Government bonds were modestly higher for the month, but are still materially lower than where they were 12 months ago.
China was the major catalyst identified for the market’s sell-off. A number of economic indicators suggested that Chinese activity continues to trend lower. China’s Industrial Production Index and Purchasing Managers Index both were below expectations. These results, in concert with additional actions by the Central Government in the form of an interest rate cut and reduction in the Reserve Requirement Ratio, underpinned the growing view that the Government sees risks to the downside for economic growth.
Japanese indicators of economic activity were broadly as expected. Asia suffered a similar mid-month sell-off, with major markets such as the Hong Kong Heng Seng and China’s main market experiencing falls of over 10%.
Other markets such as Japan and Korea held up relatively better but still saw losses in the mid-single digits.
The Australian dollar, versus the US dollar, traded in a reasonably tight range for August before trailing lower late in the month. Our currency was weaker against most other major currencies, with particular weakness versus the Japanese Yen and Eurodollar.
At 71.5 US cents at end-August, the Australian dollar is nearing what many view as ‘fair value’ but currencies can move in longer trends – so we could see the Australian dollar weaker in the medium term. Conjecture remains as to whether the RBA will move to lower the official cash rate in Australia. Such a move is likely to drive further weakness in our currency.
August proved to be another month of significant movements and some divergence across commodities. Gold and iron ore ended the month higher while other commodities such as oil, copper and aluminium all finished much lower.
Volatility in the oil market was extreme, with the price of Brent crude oil falling below US$43 per barrel intra-month before rallying back above US$50 per barrel at the start of September. China remains a dominant consumer of many of these commodities and so the outlook for their consumption will remain a major driver of commodity prices.