Market update

May 2018

May proved to be an interesting month, with significant volatility in some markets and relative calm in others. International share markets performed well overall, however results varied widely depending on the region. The US, UK and Canada saw strong gains while Continental Europe missed out. In Australian dollar (AUD) terms, international shares returned 0.4%, but in local currency terms returns were 1.0%, the difference being the impact of a rising Australian dollar. The Australian share market had a good month returning 1.1%, while the Australian bond market rebounded, returning 0.7% after weakness in April.

Geopolitical influence

May continued the trend of recent months with geopolitical developments seeming to have a bigger effect on markets than economic data. This is because developed market economies continue to travel along relatively smoothly and economic data and company profits have generally been positive. Still, some developments in May such as political instability in Italy and the continuation of US/China trade tensions are likely to heighten investor anxiety for some time.

Is a trade war on the cards?

Evidence of a potential trade war could add to investor concerns, with the US announcing that the Eurozone, Canada and Mexico will face tariffs on steel and aluminium. The tariffs were announced months ago but these economies had previously been exempt. Their inclusion now creates the potential for these economies to strike back with tariffs of their own. The US is fighting a battle on multiple trade fronts. Tensions with China also continue and President Trump’s decision to withdraw from the Joint Comprehensive Plan of Action (the Iran nuclear deal) places the nation further at odds with other developed economies. Only time will tell whether Trump’s manoeuvres succeed or fail. In the meantime, investors need to be prepared for further surprises.

Italian politics pressure markets  

Political uncertainty in Italy also dominated the news in May. Markets fluctuated quickly as investors speculated whether a coalition government would form. News that a fresh general election would not be required was welcomed by some, with others were concerned about the long-term implications of the new populist government’s proposed policies, some of which go against European Union rules. This turmoil saw the Italian equity market drop 8.0% over the month and sent the country’s bond yields soaring.

The below chart shows the difference between Italian and German 10-year bond yields reached a new high in late May. The increase in the difference between the two bonds indicates investors see the relative risks of investing in Italy as higher than those of investing in Germany.

No surprises in economic data  

In terms of economic data released over the month, there were no major surprises. Indicators for the Eurozone were positive, although there is some evidence that growth is slowing. In the UK, growth for the first quarter of 2018 remains very low at just 0.1% which added to fears of a slowing UK economy and continued uncertainty about Brexit. In the US however, the economy continues to power on, with unemployment falling to a new low of 3.8%, equal to the previous low seen before the slowdown of the early 2000s.

In Australia, March retail sales disappointed but April data beat expectations, providing some hope to retailers. However, patchy results mean consumers are still worried about spending in an uncertain environment. Unemployment rose by 0.1% to 5.6% and inflation remained contained at around 2% meaning the Reserve Bank of Australia (RBA) continues to keep interest rates on hold. The fallout from the Banking Royal Commission has also played into future uncertainty with the banks tightening their lending standards, another reason for the RBA to remain cautious on increasing rates.

Summary

Overall, the risks of a recession remain low and federal and state spending on infrastructure is providing a boost to the domestic economy.  Although we remain optimistic with regard to the global growth outlook, the volatility seen in equity and bond markets so far this year serve as a reminder of the importance of maintaining a diversified portfolio. This is key to EISS’ investment strategy of protecting your capital whilst also participating in upside investment returns.  We look forward to updating you next month.


1 Source: Bloomberg Finance L.P.  Past performance should not be regarded as an indication of future performance.

Need help? Click to talk to someone who can help you.