Investment commentary July 2015
In July we saw some significant moves in equity markets, and bond yields generally fell. The most spectacular moves were in China, where the extraordinary bull market of the last year met with a sharp correction. Elsewhere performance was mostly positive and in some areas, quite strong. Both growth assets and defensive assets rose in July and a large fall in the Australian dollar further contributed to portfolios with unhedged international assets.
After a shaky start Australian shares finished up over 4% in July, recovering most of the losses from June. Despite this overall strength there were negative returns across the resources sector due to ongoing weakness in commodities and concerns about Chinese growth. Bond yields fell again, after having risen for the last three consecutive months.
Despite the poor sentiment in the mining sector, the wider Australian economy is benefiting from lower interest rates, the strong housing market and somewhat of a recovery in consumer confidence following the more “friendly” 2015 budget. Unemployment is back at 6% after its recent peak of 6.3% in January. If it manages to stay around these levels, the transition to the post-mining boom era will have been navigated quite successfully.
Economic data in the US continued the positive rebound from the weather-effected first quarter, with economic growth annualising at a 2.3% rate in the quarter to June. Jobs growth remains steady and wages in the private sector are growing at a faster pace than at any time since the Global Financial Crisis. The Federal Reserve remains on track to raise rates later this year, taking the first step towards the normalisation of monetary policy.
US companies with exposure to the energy sector are reporting significant falls in earnings, as are those with offshore revenues where the rise in the US dollar has had a negative translation effect.
Companies with largely domestic, non-energy focussed businesses though, are growing at a healthy rate, consistent with the positive economic growth figures we’re seeing.
The referendum held in Greece in early July resulted in a conclusive vote against accepting the conditions attached to an extension of the bailout program. Despite this, the Greek Prime Minister, unable to negotiate a better deal, asked his parliament to approve what was essentially the same package that he had enthusiastically campaigned against only a week earlier. The parliament approved the deal and the bailout was extended. It still seems unlikely that the debt will ever be repaid in full and the IMF is pushing to have the debt restructured to put the Greek economy in a better position to return to economic health.
Bond yields in Europe fell in July and yield on the debt of the weaker Euro member countries is again converging towards that of Germany. Share markets in Europe were strong performers as the risk of a messy Greek exit from the Euro receded.
The Chinese equity market has been on a wild ride over the last year, rising around 150% to its peak in mid-June. While the bull market started from a position where Chinese stocks were arguably quite undervalued, fundamental measures of value soon went by the wayside as a bubble developed, fuelled by momentum and increasing levels of leverage. This bubble was comprehensively burst in June and July when the market fell some 30% in a few weeks, prompting a range of increasingly interventionist measures from the Chinese government to arrest the slide.
By early August the market appears to have stabilised, and estimates of the economic impact of the crash are relatively benign. Underlying all of this however is the growing consensus that the reform measures being implemented to reduce corruption and refocus the economy on domestic growth have had a dampening effect on growth.
The official growth number for the quarter to June was exactly in line with the 7% target, but few in the market have confidence that actual growth has been that strong.
Japan is China’s biggest trading partner, so the slowdown in China has spilled over somewhat and the Japanese economy shrank slightly in the quarter to June. Despite this Japanese stocks rose in July, probably on the expectation that the weakness in the economy would prompt an additional stimulatory policy response from the Bank of Japan.
The Australian dollar fell against the US dollar and against most other currencies. At US$0.734 it is now trading close to long term measures of value. Given the prospects for the Australian economy and for interest rates here, we expect our currency to remain weaker against currencies where central banks are closer to raising rates, such as the US and the UK. The outlook is more mixed against the Euro and the Japanese Yen, where further central bank action is expected to keep their currencies weak.