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Investment commentary March 2016


Quick overview

  • Markets have become very pessimistic about the outlook for the global economy.  Bond yields are at extremely low levels, pricing in subdued inflation over the long term despite significant ongoing monetary stimulus.
  • Our expectation is that this view will change as the incoming economic data over the next few months confirms a below average, but steadily improving, rate of growth. This will likely prompt some re-pricing of defensive assets, and possibly even small negative returns for fixed income investments.
  • Diversification in this uncertain environment is important, as is maintaining flexibility and being willing to adapt to changes in the market – and to new information – as it comes to hand.

Australia

That favourite Australian topic of residential property prices again captured the headlines in late February.  The Australian Financial Review wrote a colourful story of the adventures of two hedge fund managers pretending to be first home buyers house shopping in western Sydney. They met with some 20 mortgage brokers and several property developers.  Their take was that lending standards are alarmingly poor, and prices for new units are significantly higher than the development cost. By their reckoning this sets the scene for a spectacular fall in prices of the like that has never been seen in this country before. 

The banks soon responded, defending their lending standards, and more level headed commentators suggested a flat to slightly down trajectory for prices was more likely. Meanwhile the RBA, who mentioned rising risks in the housing market several times last year, are recently sounding more comfortable.

Australian shares fell -1.8% in February and were quite volatile. The best performing sector was resources, which rose 7.5% for the month, but are still down -25% since the start of the financial year.

United States

Inflation in the US bottomed out in the middle of last year, and the Federal Reserve’s favoured measure of inflation, Core PCE, reached a rate of 1.7% in the year to January. While the central bank is expected to keep rates on hold in March, they will be worried about the risk of rising inflation becoming a problem later on. What they’d like to avoid is a situation where they need to raise rates quickly because this would have a negative impact on the economy and could lead to a recession.

US shares were flat over February. Despite the higher inflation data, 10-year bond yields remain near-record lows at 1.7%.

Europe

Britain will hold a referendum in June on whether or not to remain in the European Union. Polls have been mixed but are reasonably close, even though it’s unclear what would follow should a vote to exit occur. Markets don’t like uncertainty and the British pound has fallen 5.5% against the US dollar so far this calendar year. European shares fell -3.2% for the month but the resources and energy-heavy UK share market rose 0.8%.

Asia

The Bank of Japan surprised everyone with a radical change to monetary policy in late January, moving to a tiered policy rate setting with negative interest rates. Government bond yields in Japan are now negative out to 10 years, and home buyers can get a 15-year fixed rate mortgage for 1.25%.

After initially falling on the news, the Japanese currency somewhat counter-intuitively rose nearly 5% against the US dollar over February. The Japanese stock market saw wild swings and the highest level of volatility since the Global Financial Crisis of 2008, and finished down -9.3%.

Currency

The Australian dollar traded in a very tight range over the month, between US70.5c and US71.4c. Fair value, measured by purchasing power parity, is around 73c. But in the short term, the currency is being driven by volatility in commodity prices and sentiment on global economic growth.