Market update

July 2017

July was another disappointing month for Australian equity investors, with the local equity market flat for the month. The result for international markets was heavily influenced by the strengthening Australian dollar (AUD), with the MSCI World ex-Australia Index down by 1.7% in unhedged terms but was actually up 1.5% in hedged terms. The rather stark contrast is mostly due to the weakening US dollar, which has been under pressure during a period of instability in the US government. The AUD now stands at US$0.80 at the end of July. Global listed property markets had a poor month, however bond markets were resilient with the local market returning +0.2%.

With the exception of the US, equity market performance over the month was fairly muted. For example, in local currency terms Europe returned +0.3%, Japan -0.5% and the UK +0.9%. This compares to the US, which posted a reasonably strong return of +2.1% and the US equity market index, the S&P 500, reached an all-time high during the month. US equities have posted a strong return of +11.6% so far this calendar year (see chart on page 2), much of this driven by the weaker US dollar. Investors’ more modest expectations with regards to US inflation and interest rate hikes has also been a driver of the US market.

With regards to the Australian equity market, it has had more modest returns in 2017, returning 3.2% for the YTD. The stronger AUD has been a headwind for the local market. Although equity markets have had a soft 3 months, bond markets have been a small positive offset returning +0.5% over the 3 month period.

On the data front, both developed and emerging economies continue to encourage investors. In the US, GDP growth was strong at +2.6% (quarter on quarter, annualised) whilst manufacturing data and consumer confidence remains elevated. US unemployment remains very low at 4.4% and is expected to stay low given the ongoing strength of the US economy and mild wage pressure.

In Europe, consumer confidence remains adequate, but varies across the continent. Germany remains the main driver of growth whilst Italy and to a lesser extent Spain are experiencing more challenging conditions. Meanwhile, the UK has continued its steady economic improvement with the unemployment rate a low 4.5%, its lowest level since 1975, and interest rates remain on hold while the uncertainty on Brexit continues.

Turning to China, data was positive with manufacturing data indicating a move to an expansion of the sector, while GDP growth was at 6.9% (year on year), slightly better than expected. We expect GDP to continue to remain at strong levels over the medium term, and believe that volatility in the Chinese equity market is more likely to be triggered by policy and macroeconomic factors rather than economic data.

Apart from the US, Canada is the only other developed country that is currently increasing interest rates with the Bank of Canada increasing rates by 0.25% to 0.75%, the bank’s first move since 2015. The Canadian and Australian economies are often compared due to the considerable exposure both have to the resources sector, so it is noteworthy that the Reserve Bank of Australia (RBA) left the cash rate on hold at 1.5%, and is expected to do so until at least 2018. The RBA’s decision was influenced, among other things, by the strong AUD (which it does not want to push higher), and weak wage growth. Later in the month inflation was below the RBA’s 2 3% target rate, further reducing upwards pressure on the cash rate.

Summary

Although equity market returns in July were challenged in AUD terms, the fact that the AUD is at a two-year high relative to the USD played a big part. The past year has been a very favourable one for equity markets across the globe, however it is unlikely these strong returns can continue without some form of correction along the way. Nonetheless, the overall outlook for markets remains positive given the lack of inflation concerns and expectations of very low interest rates to continue for some time. We see the current investment environment as reasonably positive and remain prepared to take advantage of opportunities as they arise.

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