After the weakness experienced in May, share markets bounced back in June. The main factor in this was the indication of a future shift towards lower interest rates by Central Banks around the world. International share markets rallied more than 5% in unhedged terms to finish the financial year with a return of 11.9%. Returns came from all the major markets, with US shares gaining more than 7% and European shares more than 6%. The rest of Europe and emerging markets were also strong. The Australian share market lagged behind international markets, but still managed a very respectable 3.7% return for the month and 11.5% for the year. Bond markets benefitted from positive sentiment, finishing the financial year with a very strong 9.6% return. Commercial property markets also had a very strong year, returning 14.6%.
Overall, despite some volatility in the fourth quarter of 2018, the result for investment markets for the financial year was very good and highlights the importance of sticking with your investment strategy rather than reacting to short term volatility in markets.
Interest rate cuts, how many and how quickly they would come were top of mind for investors during the month which arguably drove their appetite for shares. Current expectations are for the US Federal Reserve to cut interest rates, possibly by as much as 0.50%, over the next six months, but it will depend on economic conditions and the fallout from any US-China trade negotiations.
Federal Reserve Chair, Jerome Powell said at the June press conference “an ounce of prevention is worth a pound of cure”. His view was in line with comments previously made by other members of the Federal Open Market Committee, the part of the US Federal Reserve (Fed) responsible for setting interest rate policy. These comments were taken to suggest that a rate cut by the Fed is more a question of when rather than if, and this led to government bond yields falling in June.
The Fed was not the only thing that caused investors to suddenly change their attitudes toward risk assets. Comments from EU president Mario Draghi also drove markets to price in rate cuts by the European Central Bank as early as September. The expectation is that this may be accompanied by further quantitative easing (a policy used by central banks to stimulate the economy) as a way to boost inflation and wage growth across Europe.
Perhaps of greater importance to Australian investors was the Reserve Bank of Australia’s (RBA) decision to cut the cash rate for a second time in as many months, to the new historical low of 1.00% (see chart below). This second cut was well anticipated, and it is expected to be followed by another cut by the end of this year. Of course, a lot can change between now and then, but in the interim these two cuts should provide a decent tailwind to our struggling housing and retail sectors. With the cash rate at such a low level, each successive rate cut is likely to be less effective as a means of stimulating the economy, as banks are less likely to pass on each cut to households in full.
In terms of geopolitical news, the key event over June was the meeting between US President Trump and China’s Prime Minister Xi. As expected, nothing was agreed in terms of the trade negotiations, but the positives from it were that they agreed to further negotiations and there were no new tariffs imposed. Markets reacted positively to this as the potential for another flare up in tensions seemed to fade away, at least for now. In some respects, markets needed this result as there have been signs of global economic growth slowing recently and some small increases in unemployment in developed countries outside the US.
While it was pleasing to see share markets fully rebound from May’s weakness and finish the financial year on a strong note, there remain risks that mean a cautiously optimistic approach is still warranted. The strong June returns were driven primarily by expectations of further interest rate cuts, and while these are indeed generally positive for both share and bond markets, they also signal a potential slowing of the global economy. Further share market volatility is expected, but on a longer time horizon there remains a generally positive outlook for share markets. Returns from cash are however expected to remain at very low levels for many years.
At EISS Super we remain focussed on investing for the long term to help you achieve your retirement goals and our investment options remain well diversified and well positioned to achieve their long term objectives.
1 Bloomberg Finance L.P. Past performance should not be regarded as an indication of future performance.
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