Financial commentary

Financial year 2009/10

The 2009/10 financial year was a year of two halves. After a fantastic first six months where the Australian share market was up over 25%, the next six months saw it retreat back 10% to finish the year with a positive return just over 13%. Coming off the back of one of the worst financial years in history, at first glance a 13% return would appear to be reassuring, but there are underlying problems that need to be resolved if markets are going to advance from here.

Australia emerged from the global financial crisis (GFC) better than any developed nation. The Reserve Bank of Australia started to raise interest rates from as early as last October (bearing in mind that the US, UK and Europe still haven't begun). Consecutive rate rises followed with the overnight cash rate reaching 4.5% by June 2010. Further to this, unemployment continued to fall; going from a level of 5.8% in July 2009 to 5.2% in June 2010. Add to this an annual inflation rate of 2.9% and annual GDP growth at 2.7% and it is easy to see why Australia has been the envy of the world in an economic sense.

The Australian Dollar (AUD) was closely watched by traders throughout the year and displayed its capacity for volatility by peaking at around 94 US cents and falling to 81 US cents within the space of two months as investors lost confidence and became concerned about the supposedly risky nature of the AUD preferring the seemingly 'safer' US Dollar.

The US economy still looks shaky and didn't really achieve any real stability throughout the year. US unemployment rose in the first half of the year, peaking at a rate of 10.1% before dropping down to 9.7% by June 2010. This left the Federal Reserve (the US central bank) with very little choice but to leave cash rates at close to zero for the entire year, and it indicated that this is likely to be the case for an extended period of time. Despite this stimulus, there was little in the way of inflation indicating that consumers are just not willing to spend while unemployment remains a real threat.

Like Australia, it was a financial year of two halves for world markets. The first half started where the last one left off with significant positive monthly returns for five of the first six months. Investors responded to the sell-down of the previous 18 months during the GFC, which saw shares trading at valuations that were too cheap to ignore. From January onwards, though, it was a different story as broader economic factors, such as unemployment, inflation and growth forecasts, drove markets down.

As the recovery began to falter, concerns emerged that some European nations would be unable to repay their debt obligations and might require bail-outs from the European Central Bank and the International Monetary Fund. This sparked a lot of fear in financial markets as investors were concerned about the effects that this would have on the European banking system and corporate access to credit. These fears dampened returns in the last quarter of the financial year and until they are addressed may continue to weigh on investor confidence.

June quarter 2010

The main focus of economic news turned to Europe during the quarter with several countries including Greece, Spain, Portugal, Ireland and Italy facing doubts about whether they would be able to meet their debt obligations. Greece, in particular, had its debt rating cut to below investment grade as the risk of a default increased. This sparked a big sell-down in global share markets as concerns emerged about which companies had exposure to the debt of these nations and what effect it would have on the wider European economy.

Domestically, the overriding feature of the Australian economy seemed to be stability. Unemployment has levelled out at a rate of 5.2% by the end of June and the rate of inflation is within the Reserve Bank's target range. One worrying area of the economy is the rate of property price increases with numbers indicating a year-on-year increase of 20%. This has been one of the reasons the RBA has been inclined to raise interest rates. With a pull-back in the first home buyers grant and other housing initiatives, this rapid increase in prices is unlikely to continue, but how the housing market performs without artificial stimulus is something to watch out for.

In the US, there are still structural issues that need to be addressed before investors can start to believe in a sustained economic recovery. The level of household debt is still at very high levels and with unemployment remaining in the 9.5-10% range it is difficult to see this improving any time soon.

The market commentary below is provided to give an indication of the various factors affecting the investment performance of individual asset classes. It is based only on the gross performance of the relevant market index and no allowance is made for taxes or fees as they apply in your superannuation investment. It is provided merely as an indication of relative performance between asset classes and should not be used as a measure for judging the performance of your investment strategy.

Australian Equities

The Australian share market benchmark, the S&P/ASX200 Accumulation Index, returned -11.1% for the quarter. The market really struggled after a good start to the quarter with a 6.5% return in April. From there, though, it was all downhill with mainly macroeconomic news driving the market down as concerns emerged about the debt situation in some European states and its ramifications.

International Equities

International shares, like the domestic market, performed poorly after a positive start with the benchmark for global shares, the MSCI World ex-Australia Index, returning -11.8% on a currency hedged basis. The currency impact was significant in the quarter with the Australian Dollar falling against most of the major currencies, with the exception of the Euro. It is difficult to see where the markets will go from here but they are sure to be volatile for the next few months.

Listed Property

Australian Listed Property finished the quarter down with the S&P/ASX200 A-REIT Accumulation index returning -1.3%. This was a considerably better performance than shares in general as the property fundamentals limited the downside. Previously, listed property companies had received significant sell-downs due to their high levels of debt but, after significant capital raisings, investors were able to focus on the underlying property valuations, which have remained relatively stable and provided some growth.

Cash and Fixed Interest

There were a further two interest rate rises in the quarter with the Reserve Bank of Australia raising rates by 0.25% in April and May amidst concerns that the economy may be growing at too fast a rate following the general recovery. Rates are now at a level considered to be 'normal' as the stimulatory Government spending measures of last year have been progressively removed or wound back. There is scope for further rate rises but this is likely to be at a much slower pace than we have seen so far.

Short-term money markets produced decent returns with the UBS Bank Bill Index finishing up 3.6% for the quarter. Bond markets also produced significant returns over the quarter (particularly when compared with shares) with the UBS Australian Government Bond Index returning 4.1% as investors sought quality investments as a replacement for shares. Globally, government bond prices increased with the benchmark S&P/Citigroup World Government Bond Index (Hedged) returning 3.5% as the 'flight-to-quality' extended to global bond markets.