Investment commentary May 2015
In May we saw weakness in Australian bank shares and another rate cut from the Reserve Bank of Australia (RBA). Mediocre economic data out of the US continued but the Fed remains optimistic that they will begin to raise interest rates by year end. The big story of the month has been the game of brinksmanship in Europe over the debt structure of Greece, and its potential exit from the Euro currency.
The RBA cut rates to 2.00% in May, citing concerns about global growth and resources demand, and the impact of this on business investment in the domestic economy. They noted the positive impact that low interest rates were having on household spending, and were optimistic this would encourage employment growth. Another positive boost to consumer sentiment came from the Australian Government’s 2015 budget. While approximately 91,000 pensioners will lose age pension benefits under the proposals, this budget was seen as more generous than the 2014 budget, dropping some of the more controversial savings measures and boosting incentives for small business investment.
Australian shares rose slightly in May, but there was some volatility during the month – the banking sector experienced falls on disappointing earnings results and the expectation that they will need to build up more capital.
The US economic slowdown in the first quarter has pushed back expectations for the first rise in interest rates, which have been near zero for over six years now. In a speech during May, Federal Reserve Chair Janet Yellen said she expects growth to pick up over the rest of the year and that they would be in a position to begin normalising interest rates by the end of the year. Once begun, this process of normalisation is likely to be gradual, as the risk to the downside for the economy of moving too fast far outweighs the potential for higher inflation if they move too slowly.
Earnings for US stocks rose just over 2% in the year to March, but this average includes the significant decline in earnings for energy-related stocks of nearly 60%. Excluding energy companies, the average growth rate in earnings was a more respectable 7.5%. Both equities and bond yields rose slightly for the month.
The background of improving economic performance in Europe is being overshadowed by the drama of Greece’s negotiations with the European Union, European Central Bank and the International Monetary Fund (collectively known as ‘the Troika’) over an extension to the 2010 bailout package. The Greek government was elected on a promise to end the austerity measures imposed as part of the bailout package, which have seen government spending fall by around 20% of GDP, and wages fall by 25%. The impact of this on the Greek economy has been far more severe than had been expected in 2010, and unemployment is now running at 28%.
With overall debt to GDP of around 180%, there is little chance that Greece will ever be able to repay its debt, so the negotiations with the Troika are really about deciding the terms and timing of default. The Troika are demanding that Greece cut public pensions and act further to reduce corruption and tax avoidance, in return for extending the bailout beyond 30 June. The Greek government is refusing to contemplate further cuts to pensions. Whether we see another extension of the bailout, or an outright default and exit from the Euro, the outlook for Greece in the medium term remains bleak.
European shares were volatile but ended roughly flat in May, and bond yields rose for the second month in a row.
In May, China’s Central Bank cut interest rates for the third time in six months following a loosening of bank reserve ratios in April. This policy easing comes as the economy transitions to a more domestic-led growth model and experiences lower absolute levels of economic growth. Chinese share markets have risen over 100% since mid-2014 and levels of margin debt have skyrocketed.
On most measures now, Chinese stocks look expensive and some sectors are clearly in bubble territory.
In Japan unemployment fell to 3.3%, the lowest since 1992, and economic growth for the first quarter surprised on the upside. Despite this, sentiment remains weak and consumption growth low, and inflation is barely above zero.
The Australian dollar rose to US81c mid-month before trending lower to finish at US76.5c. This is a fall of around 18% over the last 12 months, but it has mostly been about a rise in the US dollar.
Measured in British pounds, the Australian dollar has fallen just 9.6%, and has actually risen against the Japanese Yen and the Euro. We expect currency volatility to remain a feature of markets over the medium term due to the divergence of outlook for major economies.
The oil price fell in May and it was iron ore’s turn to rally strongly, rising 17.6%. Gold bullion rose 1% to finish the month at US$1,190 per oz. Gold is seen as a store of value and its price has tended to rise during periods of financial instability or when investors fear inflation. The gold price peaked in 2011 at US$1,856 and its decline since can be attributed to the improvement in global economic stability and the very low levels of inflation experienced in recent years.