The market wrap is a summary of September's economic highlights across the globe.
Indicators regarding the strength of the US economy have been mixed recently. The latest survey showed conditions have deteriorated markedly for manufacturers, for example. The ongoing trade dispute with China appears to be eroding confidence among US firms, affecting their investment plans.
More encouragingly, the ISM non-manufacturing index came in well above consensus expectations, suggesting conditions are more resilient in the services sector.
Consumer spending in the US is being supported by rising employment and solid earnings growth. Wages are rising at more than 3% a year, well above the pace in Australia.
Despite the strong demand for goods and services, inflation remains slightly below target. This suggests policy makers will be able to lower interest rates again, if required.
Interest rates were unchanged at the RBA’s meeting in September. As anticipated, they were subsequently lowered by 0.25 percentage points on 1 October, to 0.75%.
According to policymakers, easier monetary policy settings are required to support employment and income growth and, in turn, help drive inflation back up towards the 2% to 3% target band.
Despite solid employment growth in this cycle, the local economy still has spare capacity and the RBA believes lower borrowing costs will help make inroads into that.
Officials believe the unprecedented low level of interest rates, tax cuts following the Federal Election, ongoing infrastructure spending, signs of stabilisation in the Sydney and Melbourne housing markets and a brighter outlook for the resources sector will help support the growth outlook.
Subdued consumer spending appears to be the main risk to the economic outlook. With subdued wage growth, households are seeing only modest increases in disposable income, even given lower mortgage servicing costs.
Employment trends have been encouragingly strong, although the official unemployment rate has remained steady at around 5¼ per cent in recent months, as increased demand for labour has been met by more supply.
Investors were primarily focused on the European Central Bank’s meeting in mid-month. As anticipated, officials announced a monetary stimulus package designed to stimulate activity levels in the Eurozone economy. The Bank will recommence asset purchases at a rate of 20 billion euros per month, which will inject liquidity into the financial system and should, in turn, promote lending and activity levels.
Business sentiment in the Eurozone has fallen to its lowest level in six years, dragged down by ongoing uncertainty over how Brexit will affect European firms. Slower growth in China is also affecting demand for European exports, including cars and other manufactured goods.
The closely watched survey of economic expectations in Germany improved, but remained negative. This suggests growth in Europe's largest economy could be slightly negative in Q3 and Q4, following a small contraction in Q2.
In the UK, the ongoing Brexit debacle continued to dominate attention. Prime Minister Johnson’s ‘prorogation’ of Parliament in August was deemed to have been unlawful, prompting renewed calls for his resignation. He refused of course, instead offering a general election. Johnson is seeking a larger majority, which may enable him to press ahead with his Brexit proposals. The opposition Labour Party refused the election request and so the Brexit stalemate went on…
Theoretically, the UK is due to withdraw from the European Union within the next month. However, with MPs unable to agree on the best way forward, a further extension of the process appears possible. The Brexit can could be kicked down the road for a few more months yet, increasing the probability of recession in both the UK and Continental Europe.
The month got off to a promising start, with Chinese manufacturing data for August coming in ahead of expectations. The 50.4 reading was ahead of consensus forecasts and, importantly, was above the 50 level indicating expansion rather than contraction. Services data was also stronger than expected, resulting in a rebound in the Composite PMI reading.
The reading was somewhat inconsistent with subdued export data. The effects of higher tariffs on goods exported to the US are affecting trade volumes and, in turn, factory output.
Retail sales growth data were also below expectations. This was a little concerning - with export volumes tailing off, it is important that domestic demand remains firm.
Like in other regions, Chinese authorities have been easing monetary policy settings in an attempt to support activity levels. The Loan Prime Rate – the key benchmark for lending to businesses and households – was reduced in September.
In Japan, retail sales data rebounded more than expected but other leading indicators were little changed over the month.
The ‘Aussie’ strengthened against the US dollar, though not by a significant amount. At month end, one Australian dollar bought 67.5 US cents. The Australian dollar also strengthened against a trade-weighted basket of international currencies, performing particularly well against the Japanese yen.
After posting strong gains in recent months, Gold (- 1.5%) finished lower, as US 10-year real yields rose during the month.
Oil (Brent +1.4%) rose following disruption to Saudi Arabia’s oil infrastructure. Saudi Arabia restored oil production capability faster than expected, however, tempering price gains.
Iron ore (+2.2%) tracked higher on restocking demand in China, and optimism demand may remain strong during October.
Industrial metals, including copper (+0.6%), lead (+1.4%) and zinc (+4.0%), finished mostly higher on easing US/China trade tensions.
The increasing likelihood of interest rate cuts in Australia was sufficient to propel the S&P/ASX 100 Accumulation Index (+1.8%) into positive territory. The change in interest rate expectations occurred on the back of comments in the minutes of the RBA’s latest meeting and mixed employment data.
Constituents of the Energy sector (+4.9%) benefited from a recovery in oil and gas prices following the disruptions to Saudi Arabia’s energy production capabilities.
Financials (+4.0%) also performed admirably. The ‘Big Four’ banks provided support and offset weakness in CYBG (-18.4%).
Underperformance from Telstra (-5.6%) weighed on the Communication Services sector (-3.9%). Telstra’s guidance came under scrutiny as NBN Co’s updated Corporate Plan guided to lower activation volumes in FY20.
Both the Real Estate (-2.5%) and Health Care (-2.4%) sectors experienced a reversal of August’s strength.
Investors’ ‘risk-on’ sentiment saw an increase in Australian bond yields during the month and a corresponding decline in equity substitutes.
Small companies (+2.6%) outperformed their large cap counterparts throughout the month, albeit only modestly, while Australian ‘value’ stocks recovered from weakness in August and closed the gap on Australian ‘growth’ stocks in September.
Global listed property securities continued their strong year-to-date run and posted solid gains in September.
The FTSE EPRA/NAREIT Developed Index rose 2.5% in USD terms and 2.4% in AUD terms, marginally outperforming the broader global equity market.
The UK was the best performing listed property market (+6.9%), buoyed by the diminished likelihood of a ‘nodeal’ Brexit following numerous setbacks to Prime Minister Boris Johnson’s agenda.
Australia was the worst performing developed market (- 2.7%). In Australia, Retail A-REITs outperformed for a second consecutive month (-1.3%), while Office A-REITs were the worst performing sub-sector (-5.8%).
The strongest performers in Australia included Unibail-Rodamco-Westfield (+6.0%) and Cromwell Property Group (+4.8%). Both stocks rallied following the announcement of their latest results.
Global equities bounced back in September as investor risk appetite returned.
There were easing fears of further deterioration in the trade spat between the US and China and greater monetary stimulus in key regions – policy settings were eased in China, Europe and the US.
The MSCI World Index jumped 2.4% in local currency terms, but an appreciating AUD pegged back the equivalent returns to 2.1% for Australian-based investors.
Japan was the strongest performing market, with the Nikkei surging more than 5.0% in local currency terms; the yen sold off along with other ‘safe-haven’ assets. This helped boost the shares of Japanese exporters including carmakers and large electronics companies including Sony and Sharp.
At the other end of the scale, Australian shares were among the laggards in developed markets.
US stocks also underperformed, partly due to uncertainty around a possible impeachment of the President.
The US S&P 500 Index returned 1.8% in local currency terms. This brought up the strongest nine-months to end September since 1997 and leaves the S&P 500 Index just 1.3% away from its all-time high.
Emerging markets continued to drift away from their developed counterparts, underperforming them for an eighth straight month.
The MSCI Emerging Markets Index rose 1.8% in AUD terms. The MSCI World Value Index has also lagged over 2019, though bounced back in September returning 3.9% in AUD terms versus a meagre 0.4% return from the Growth equivalent.
This was the first time value stocks had outperformed growth stocks globally since November last year as investors rotated out of the winners in 2019-to-date – defensive and growth stocks – and into relatively unloved value stocks.
Global and Australian Fixed Income
Major government bond markets generated negative returns in September, following several months of strong gains.
Benchmark 10-year yields in the US, Europe and Australia all rose by between 10 and 20 basis points, although increases were more modest in Japan and the UK.
Despite the increases, bond yields remained negative in many parts of the world.
While US interest rates were lowered during the month, a breakdown of Federal Reserve Board Member votes indicated some resistance to lower rates. Market expectations still suggest the next move in the Federal Funds rate will be downwards, but possibly not until 2020. This appeared to provide some support to Treasury yields and, in turn, those in other countries.
In Australia, semi government spreads widened a little, resulting in negative returns from State Government bonds.
September saw a very large amount of new corporate bond issuance. In a two-week period alone, more than US$100 billion of new paper was issued, making it the biggest fortnight of new issuance ever.
With Treasury yields so low and with credit spreads tightening, corporates are being incentivised to raise capital with historically low borrowing costs.
Investment grade spreads continued to move lower, by 5bps during the month. In spite of the increasingly uncertain economic background, corporate profitability remains in reasonably good shape and default risk remains relatively low. The increased yields on offer in corporate bond markets are therefore proving appealing for investors in search of income.
High Yield credit has performed well against this background and again outperformed the Investment Grade sector in September. High Yield spreads closed the month 20bps lower, at 3.13%.
At 0.66%, Australian credit spreads were little changed over the month.
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