Market Update:

Equity markets have performed poorly for the financial year to date (i.e. 1 July 2011 to 26 September 2011).  The main issue affecting markets is the risk that the current European and US sovereign debt crisis will cause a second Global economic recession.

Recent economic news has reinforced that the expected rate of growth in the US and Europe is currently in the range 1-2% pa, compared to the range of 2-3% less than 12 months ago. In addition the high unemployment rate of 9.1% and lack of recovery in property markets in the US is reinforcing expectation of a slow, drawn out recovery.

The return from equity markets in the short term can be largely driven by sentiment (as measured by consumer and business confidence).  These sentiment measures have been falling significantly in recent weeks in Australia and overseas.

We expect that sentiment will only start to change if a viable and sustainable long term solution can be found to managing US and European debt issues without imposing global austerity measures which result in a global economic recession.

Based on current world economic growth expectations issued by the International Monetary Fund this week (growth of 3-4% pa over the next 12-24 months), we expect that equities have been oversold and continue to represent good value with a 2-4 year investment timeframe.  However, in the short term we do not expect any significant rebound at this point in time.  If world economic growth slows significantly, further equity market weakness is possible.

The remainder of this newsletter provides an overview of market action in major asset class for the month of August 2011.

Australian shares

The S&P/ASX 200 Accumulation Index declined by 1.9% in August, but this outcome masked an extraordinary level of volatility in the domestic share market. The Index was quite volatile during the month – reflecting the fragility of investor confidence in financial markets.

Investor attention was dominated by the financial stability of Europe and concerns over a deceleration in the pace of global growth. The extreme level of market volatility diverted attention away from company earnings data, which was released for the period ending 30 June 2011.

Several companies had provided fairly specific guidance prior to their formal announcements, so the reports held few major surprises. As a guide, approximately three quarters of companies reported earnings which were broadly in line with our expectations, a few surprised on the upside and fewer still genuinely disappointed. BHP’s profit result of $22.5 Billion  reflected a very strong year for mining stocks. Share buybacks were a key feature of the month, with several companies announcing capital management initiatives.

Strong balance sheets also continued to support a level of merger and acquisition activity – August saw takeover bids for Coal and Allied, Macarthur Coal, Fosters and Minara Resources.

Defensive sectors tended to outperform against the falling market, with Utilities, Telecoms and Consumer Staples among the best performers. More cyclical sectors tended to underperform, as investors continued to question the outlook for Australian and offshore economic activity.

Global shares

Global equity markets fell sharply in August as investors moved out of risk assets and into US Treasuries on lower global growth expectations. Equity markets are now keenly watching and anticipating another round of quantitative easing by the Federal Reserve and reacting to each economic data release.

The MSCI World Net Index fell 7.3% in USD terms and 4.9% in AUD terms in August. The Dow fell 4.4%, the S&P 500 was down 5.7% and the NASDAQ fell 6.4%. The Dow Jones remains 16% higher than 12 months ago.

European markets were weaker, recording the sharpest falls since the collapse of Lehman Brothers in 2008. Volumes were sharply higher as investors repositioned portfolios. The German DAX recorded sharp falls early in the month in line with other markets but failed to recover, recording losses of 19.2% in August, the largest loss since September 2002. Germany did not introduce a ban on short selling. The DAX Index is now 2.4% lower over 12 months. Spain (–9.5%) and France (–11.3%) also experienced sharp falls. The Greek share market fell 23.9% in the last 12 months on concerns over its banking sector, leading to the merger of the second and third largest banks in Greece.

In Asia, markets recorded losses across the board during August. Japan (–8.9%), Hong Kong (–8.5%), South Korea (–11.9%), Singapore (-9.5%) Taiwan (–10.4%) and Malaysia (–6.6%) all recorded losses.

In terms of sector performance during August, the Financials sector (–10.1%) and Energy sector (–10.0%) were the worst performing sectors.

Global emerging markets

Emerging markets underperformed developed global equity markets in August with the MSCI Emerging Markets Index falling 9.2% in USD and 6.8% in AUD terms.

The largest falls in emerging equity markets during August occurred in Russia (–20.9%) due to sharply lower commodity prices, especially oil. Hungary (–14.6%), Turkey (–13.6%), Czech Republic (–10.8%), Poland (–10.5%) and Argentina (–10.2%) also recorded double digit losses. The Philippines fell 2.6% while Sri Lanka recorded gains, up 0.5%.

Brazil finished the month 4% lower and in early September official interest rates were cut by 50 basis points to 12%. This follows five consecutive rate hikes, indicating the emergence of risks to global economic growth and the potential impact on emerging economies. Brazil continues to face inflationary pressures, with the last data point showing inflation at 6.9%, versus a target of 4.5%.

Global fixed interest

Global bond markets saw a sharp fall in bond yields in August. Already jaded by the US debt ceiling political debate in Washington, market participants became increasingly concerned about sovereign and financial system risks in Europe and the deteriorating global economic outlook.

In response, the 10–year US Treasury bond yield plunged through 2% to 1.97% mid–month, its lowest level since 1950, before finishing the month at 2.18%. Overall, 10–year Treasury yields declined from 2.80% at the end of July, the largest monthly drop since December 2008.

In Europe, the crisis enveloping the region ratcheted up a notch during the month. Pressures on Italy, Spain and France intensified in the wake of the Greek sovereign debt restructuring. German 10–year bonds declined by 35 bps to 2.19% at August–end.

In the UK, the Monetary Policy Committee unanimously voted 9–0, the first time since May 2010, to leave the Bank of England rate at 0.5%, signalling a prolonged period of policy inertia. The UK 10–year government bond yield decreased by 26 bps to 2.60% at month–end.

In Japan, the 10–year government bond yield declined by 5 bps to finish the month at 1.03%.

Australian Fixed Interest

The Australian bond market also saw a sharp fall in yields driven largely by a deterioration of sentiment about the domestic economic outlook. Several market analysts have now predicted that the Reserve Bank of Australia (RBA) will start decreasing the official rate of 4.75% over the coming months.

Furthermore, demand from overseas central banks and offshore institutional investors increased, lured by the developed world’s highest government bond yields, strong liquidity and the relative safety of the Australian government bond market.

Australian 10–year Commonwealth government bond yields fell by 43 bps to 4.37% at August–end, having ended the previous month at 4.80%.Yields have now declined by 83 bps over the past two months, their largest fall since August–September 2008. The downward movement in 10–year yields tracked global market movements, which were driven by events in Europe and the US during the month.

Australian market participants also focused their attention on weaker domestic economic data releases during August.

The RBA left the official cash rate at 4.75% at its meeting in August. The Board meeting Minutes acknowledged that the downside risks to economic growth had become more pronounced due to ‘the uncertainty that the EU and US public finances present to the economic outlook’.

The RBA also appeared to highlight that their ‘mildly restrictive’ policy stance was already exerting sufficient downward pressure on domestic demand, saying that a ‘number of factors point to financial conditions being tighter than normal’.

Most market commentators interpreted this as a signal that the RBA is unlikely to increase interest rates for the remainder of 2011. Later in the month, RBA Governor Glenn Stevens gave a speech to the House of Representatives Standing Committee on Economics echoing the above comments but not entertaining market pricing for sharp cuts to the official cash rate.

Listed property (REITS)

The S&P/ASX 200 Property Accumulation index was up 3.1% in August 2011, outperforming the S&P/ASX 200 Accumulation Index by over 5.0%.

The UBS Global property investors’ index (local currency) decreased 5.0% in August, with Australia the top performing region (+3.2%) followed by Japan (–1.1%). The worst performing regions were the UK (–11.0%) and Singapore (–6.9%).

During the month most A–REITS reported their full year result and outperformed the broader equity market through reporting season. The larger, more defensive stocks were the top performers throughout the reporting season, while more leveraged stocks tended to underperform. Outside of results of the biggest stock news was the indicative bid for Charter Hall Office. A number of share buybacks were also announced in the sector. A number of stocks continue to trade at a discount to Net Tangible Assets.

Australian Dollar

During August, the $A fell against the US dollar (US$) and Japanese yen (JPY) and the currencies of Australia’s major training partners.  The A$ was volatile over the month in line with global share markets and swinging investor sentiment.  Falling commodity prices, and increasing expectation that the next move in Australian interest rates will be down also weighed on the currency.  The A$ closed down 2.6% against the US$, down 2.7% against the JPY and down 2.4% against the trade weighted index.

 

GENERAL ADVICE WARNING
© 2011 Harvest Financial Group Pty Ltd. This Newsletter has been prepared for clients of Harvest. This document contains confidential and proprietary information of Harvest Financial Group (‘Harvest’), and is intended for the exclusive use of the recipient to whom it is addressed. The document, and any opinions on investment products it contains, may not be modified, sold or otherwise provided, in whole or in part, to any other person or entity without Harvest’s prior written permission. Information on investment management firms contained herein has been obtained from the firms themselves and other sources. While this information is believed to be reliable, no representations or warranties are made as to the accuracy of the information presented, and no responsibility or liability, including for consequential or incidental damages, can be accepted for any error, omission or inaccuracy in this report or related materials. Opinions on investment products contained herein are not intended to convey any guarantees as to the future investment performance of these products. In addition, past performance cannot be relied on as a guide to future performance. This information has been sourced from Harvest’s independent research house Mercer Investment Consulting Research and other sources.