Investment commentary June 2015
Two major events dominated headlines in June – the breakdown in negotiations over the Greek debt bailout, and the sharp correction in the Chinese equity markets. Volatility across markets increased and investors saw losses on most growth assets, and on some bond portfolios, as yields shifted higher.
Australian shares fell more than 5% in June, wiping out nearly half the gains of the last 12 months. Bond yields rose from recent lows, so investors may have seen negative returns on both their growth and defensive assets over the month.
The Australian economy remains sluggish and the Reserve Bank of Australia (RBA) kept rates on hold at 2.00% in June. Low commodity prices have contributed to a trade deficit, which reached a record $4.1bn in April, but recovered slightly in May.
Consumer spending and the housing market have responded positively to low interest rates. Over time, the fall in the Australian dollar should make our service industries such as tourism and education more internationally competitive. There’s little political support for government investment to bridge the gap created by the end of the mining investment boom. As a result, this lacklustre ‘transition’ phase that the Australian economy is in may last for some time yet.
Update on China
China’s runaway bull market in shares had a savage correction in June, and in early July was down nearly 30% from its highs. The Central Bank cut interest rates and reserve ratios, and the government cancelled IPOs and changed the rules around margin calls to try to bring back some stability. The 150% rise in the Shanghai Composite index over the last 12 months had led to outlandish valuations in some sectors such as IT and solar power. The concurrent growth in margin debt made for a dangerous combination and the volatility in June will have caused significant losses for many first-time investors.
The Chinese market is a little unusual in that less than 2% of all shares are owned by foreigners, and trading is dominated by retail investors. This means there’s unlikely to be any significant direct impact outside of China from the recent falls. Of course there are indirect effects such as the negative impact on sentiment, which may cause a slowdown in economic growth.
As Australia’s largest trading partner and the world’s biggest consumer of many commodities, Chinese economic growth contributes to Australian economic growth and is a key variable in the outlook for some Australian shares. Other share markets that are related to China, such as Hong Kong and other Asian markets, have also seen volatility. But these markets didn’t rise as dramatically as Chinese shares, and so have fallen less.
Perhaps a more serious side effect of the bear market is the potential for social unrest, the consequences of which would be highly unpredictable. For this reason we expect the Chinese government to continue to act to support the share market and the economy through further policy measures.
At SSFS we’ve had very little direct exposure to the Chinese market, and our approach of biasing portfolios towards lower risk companies means we tend to outperform when markets sell off. Most diversified funds hold a mix of Australian and international shares, so if the situation in China worsens and the indirect effects become larger, we will not be immune from the volatility.
We remain focused on maintaining diversification and monitoring risks as they develop, and expect to deliver our targeted returns in the long term. If you have any questions about developments in markets or our approach to investing, please contact your financial planner.
Jobs growth in the US remains very strong and there are early signs that wages are starting to pick up. Inflation remains low for now, but is likely to trend higher over the rest of 2015 as the impact of last year’s oil price fall wears off. The Federal Reserve indicated they expect to raise rates at some point this year. When they do, it will be the first time rates have gone up since the start of the global financial crisis of 2008-2009. Not all the news from the US has been positive, though. The governor of Puerto Rico announced that the island territory would be unable to pay its debts and is likely to default.
The US share market was among the better performing international markets in June, falling around 2% in what was a very difficult period.
Greece dominated headlines in June as five months of difficult negotiations to extend its bailout program failed to reach agreement. Prime Minister Tsipras, unable to convince Greece’s European creditors of his alternative plans for recovery, called a referendum on 5 July for people to vote on whether or not to accept Europe’s demands for further austerity.
The resulting ‘no’ vote may see Greece forced out of the Euro currency group. The risk of contagion to other European economies seems much lower now than it was in 2012, but we’re heading into uncharted territory and expect to see significant ongoing volatility in equity, bond and currency markets.
European shares were buffeted by the geopolitical uncertainty of the Greek debt crisis, losing ground despite underlying earnings momentum continuing to improve.
Long the home of downbeat expectations, Japan is starting to become more optimistic. The Bank of Japan’s Tankan survey of big businesses surprised on the upside indicating large firms are bullish about their prospects. Consumers too are playing their part with retail sales growth for May also surprising on the upside.
The puzzle in currency markets this month was the surprising strength of the Euro. Despite fears of a Greek exit (‘Grexit’), the Euro finished the month at US$1.12, more than US7c higher than the lows reached in March this year. While the departure of Europe’s weakest economy from the common currency would arguably make the union stronger, it would be the first such exit since the Euro was created and could set a dangerous precedent.
The Australian dollar too was relatively stable, finishing the month at US77c. The dollar has tended to fall when growth assets sell off, so the resilience in June was surprising, and the usual diversification we receive from holding foreign currency denominated investments failed to materialise.