May proved to be an interesting month, both from a market performance viewpoint and a geopolitical one. Despite a short lived increase in volatility coinciding with further turmoil surrounding the Trump administration, international equities performed well, returning +2.8% in unhedged terms and dramatically outperforming Australian equities at -2.8%. The local market was weighed down by the finance sector which declined steadily over the month following the introduction of a new bank levy as part of the 2017 Federal Budget. However, the Australian bond market performed well over the month at +1.2%, outperforming global bond markets which returned +0.6%.
In Europe, Emmanuel Macron comfortably beat Marine Le Pen in France’s presidential election on 7 May, which was seen as a positive for equity markets and provided confidence in the stability of the Euro currency. Macron’s success also indicates a lower likelihood of other member countries leaving the European Union (EU), which is positive for stability in the region. The UK’s decision to leave the EU continues to play out, with the ‘snap’ election called by Theresa May resulting in the Conservative Party losing their majority and having to form a minority government with the Democratic Unionist Party.
In Australia, the Reserve Bank left the cash rate on hold at 1.5%, citing low core inflation and noting little change to the central bank’s forecasts. Governor Lowe did point to mixed signals from the labour market, however noted that indicators are still pointing towards employment growth. The month also saw the release of the Federal Budget, which featured measures aimed at addressing Australia’s housing affordability, as well as a new tax targeted at Australia’s big four banks. The Finance sector had a particularly bad month, returning -7.7%, with other headwinds such as a downgrade to Standard & Poor’s Banking Industry Country Risk Assessment (BICRA) also having a negative impact.
From an economic perspective, the US remains strong with the unemployment rate falling 0.1% to 4.4% in May, and data from the Institute for Supply Management showing that the US economy has expanded for the last 95 consecutive months. US consumer and business confidence remains high and this has been a driving force behind the very strong US equity market over the past year.
In addition to economic fundamentals, investors again focused on certain geopolitical developments during May. Firstly, news that President Trump had dismissed FBI Director James Comey, in combination with renewed concern over possible links to Russia, saw volatility increase sharply only to fall back within a matter of a few days. Although this bout of volatility was short-lived, it is worth noting that the Chicago Board Options Exchange SPX Volatility Index, commonly known as the ‘VIX’ and seen as a measure of fear amongst investors, has trended down since the Global Financial Crisis and is currently around its historical lows (see chart below). The lower the value of the index the less fear, or more confident, investors are in future returns. Other geopolitical events that influenced markets were the ongoing threats from North Korea, the upcoming UK election and the terrible terrorist events in the UK.
Geopolitical developments seem to be an increasingly important driver of markets in recent times and the month of May was no exception. Perhaps this is because fundamentals continue to be strong in most developed markets, allowing investors’ anxieties to shift elsewhere. In any case, we believe this trend will continue for the foreseeable future.
Geopolitical developments aside, we are conscious that equity markets, particularly in the US, have been very strong over the past year and are susceptible to a correction in the short term. However, this is typical of equity markets and is not a reflection of any expectation of a significant downturn in equity markets on a one year view. Overall, we remain cautiously optimistic on markets, albeit we do expect investment returns to become more moderate compared to the very good levels seen in the current financial year.
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