Investment Commentary – Quarter ended 31 December 2017

Provided by Mercer. The information in this article does not necessarily reflect the views of the Trustee.
The global economy experienced further growth over the December 2017 quarter, with developed and emerging market equities experiencing strong absolute returns.

The S&P/ASX Small Ordinaries index increased 13.7%, the largest increase over the quarter, while unhedged emerging market equities and domestic property securities experienced the second highest growth, increasing 7.8% over the period.

Another tumultuous quarter, starting off with conflict in Spain surrounding the Catalonian referendum for independence, a Japanese election, as well as continued tension between the United States (US) and North Korea, failed to put a dampener on the synchronised global growth that has characterised the global economy in 2017. In the US, President Donald Trump’s much anticipated tax reforms were given the approval by the Senate in November, providing a positive boost to growth over the quarter. Furthermore, manufacturing indicators showed consistent continued expansion across the US, Europe and China over the quarter, providing further support to economic growth.

The US Federal Reserve (Fed) had a busy period of transition over the December quarter, with the departure of four board governors, also noting the appointment of Jerome Powell, replacing Janet Yellen as Chair of the Fed in February 2018 as well as another rate hike in December, from 1.25% to 1.5%. The rate hike comes off a solid period of growth in labour and US gross domestic product (GDP), supporting its aim to ease back to 2% inflation along with sustained growth. The rate hike was unsurprising following US non-Farm payrolls increase of 211,000 in October, 252,000 in November and 148,000 in December combined with a US GDP estimate for Q3 2017 revised to 3.2% quarter on quarter (QoQ) annualised.

Domestic markets experienced a strong quarter, as the S&P/ASX 300 rose 7.7%, outperforming its hedged global counterpart by 2.2%, and with small caps leading the market, rising 13.7% for the period. Energy and IT were the strongest performing equity sectors over the period, while Domestic Real Estate Investment Trusts (REITs) also contributed to domestic performance, increasing 7.8% over the period. The Australian dollar (AUD) was relatively stable over the quarter, depreciating slightly to US$0.782, from US$0.785 in September.

The Reserve Bank of Australia (RBA) has kept a close eye on the AUD, continually expressing its view that a strong AUD will be counter-productive to economic growth, as well as affecting policy decisions with no expectations for a rate hike in the short term.

  • The RBA decided to leave the cash rate unchanged again in its early December meeting at 1.50%, the cash rate has remained at this level since August 2016. RBA Governor, Philip Lowe, noted that economic growth in the global economy has improved over 2017, with above-trend growth now expected for certain economies, while labour markets are experiencing a gradual tightening. In Australia, the economy grew at 2.8% over the September quarter, which was slightly lower than the central banks forecast for growth to remain at 3%.However, improvements in non-mining sectors and an influx of infrastructure projects supports a positive future outlook. On the other hand, low wage growth and rising household debt remain a concern, restraining household consumption. To combat the threat of rising household debt, APRA has introduced new supervisory measures and credit standards have been tightened to reduce the risk profile of borrowers. House price fluctuations have settled down in the past six months. Wage growth is expected to remain low for some time, but could improve with stronger conditions in the labour market. Australian employment growth has been strong over 2017. Underlying inflation is currently low, and expected to remain low as long as slow wage growth continues. With the gradual improvements in the economy and a view that low interest rates will continue to support the Australian economy, the RBA believed it was appropriate to leave the rate unchanged.
  • Australian seasonally adjusted employment increased by 61,600 positions in November, above expectations for a 19,000 rise while October increased by 7,800 positions (revised), below expectations for an 18,800 increase. The unemployment rate remained at 5.4%, in line with market expectations, throughout the quarter. The participation rate increased to 65.5% in October. Part time jobs increased by 19,700 in November, after decreasing by 23,200 (revised) in October. Full time jobs increased by 41,900 in November, and increased 31,000 (revised) in October.
  • Australian house prices declined by 0.2% in the third quarter 2017, but rose 8.3% from a year earlier, below expectations for 0.5% QoQ and 8.8% year on year (YoY).  Meanwhile building approvals increased 11.7% month-on-month (MoM) to be up 17.1% for the year to November, above expectations for a monthly -1.3% decrease and above for  yearly 4.6% increase. In trend terms, building approvals increased 0.9% for November, and were 8.1% higher than a year earlier.
  • US Non-Farm Payrolls increased by 148,000 in December, whilst expectations were for a 190,000 increase. November was the strongest month for US employment in the quarter, rising 252,000 (revised) over the month. October was close behind with an increase of 211,000 (revised) for the month. The unemployment rate decreased to 4.1% in the December quarter, consistent across all months. The participation rate increased to 62.7% by the end of December, from 62.1% level by the end of September.
  • The Institute for Supply Management (ISM) Manufacturing Index increased to 59.7 in December, above consensus for 58.2, and above the 58.2 recorded in November. Of the 18 manufacturing industries, Machinery, Computer and Electronic Products, and Paper products were the top contributors with only Wood Products, and Textile Mills reported a contraction in growth during December. The ISM Non-Manufacturing Index decreased to 55.9 in December, below consensus for 57.6, and below the 57.4 for November. The top performers were Retail Trade, Utilities, Arts, Entertainment and Recreation, and Other Services with Information, Educational Services, and Management of Companies and Support Services being the only industries to report contractions during December.
  • US GDP assumption was revised for Q3 2017 to 3.2% QoQ annualised, below expectations for 3.3%, and above the 3.1% growth recorded in Q2 2017.
  • US headline consumer price index (CPI) increased to 0.4% MoM and increased to 2.2% YoY to November, in line with expectations, and above the 0.1% MoM and 2.0% YoY movement in October. Core CPI decreased to 0.1% MoM, lower than expectations, and remained at 1.7% YoY, lower than expectations of 1.8% in November, from 0.2% MoM and 1.8% YoY in October.
  • The Caixin Manufacturing purchasing managers’ index (PMI) in China increased to 51.5 in December, above expectations for 50.7. The indicator continues to show positive improvements in China’s manufacturing industry.
  • Chinese GDP increased 6.8% YoY to Q3 2017, in line with expectations but lower than 6.9% recorded over the year to Q2 2017. Seasonally adjusted GDP increased 1.7% QoQ for Q3 2017, in line with expectations and below Q2 2017 level of 1.8% QoQ.
  • European Core CPI remained at 0.9% over the year to December, below expectations for 1.0%. The unemployment rate decreased to 8.7% in November, below 8.8% for October, while MoM CPI remained constant at 0.1% in November.
  • The Eurozone composite PMI increased to 58.1 in December, in line with expectations, signalling expansion for the fifty-fourth month in a row. Output expansion improved in Germany (80-month record), Italy (eight-month high) and Spain (three-month high). France saw its pace of output growth remain close to November’s high and Ireland recorded the highest pace of increase.
  • Eurozone seasonally adjusted GDP increased to 2.6% year-on-year, and remained constant at 0.6% QoQ for Q3 2017, from 2.5% and 0.6% respectively for Q2 2017.

Australian equities were positive over Q4 as the S&P/ASX 300 Index returned 7.7% for the period. There were positive movements across the market cap spectrum, with the best performer being the S&P/ASX Small Ordinaries; returning +13.7% for the quarter while the worst performer was the S&P/ASX 50; returning 6.3%. The best performing sectors were Energy (+18.3%) and IT (+16.7%) while the weakest performing sectors were Utilities (3.3%) and Financials (3.7%). The largest positive contributors to the return of the index were BHP, CBA and Rio Tinto with absolute returns of 15.8%, 6.8% and 15.2% respectively. On the other hand, the most significant detractors from performance were NAB, QANTAS and ANZ with absolute returns of -4.6%, -13.3% and -1.6% respectively.

The broad MSCI World ex Australia (NR) Index was up 5.5% in hedged terms and 5.8% in unhedged terms over the quarter, as the AUD depreciated against the major currencies over the period. The strongest performing sectors were IT (+8.7%) and Materials (+8.1%), while Utilities (-0.1%) and Healthcare (+1.2%) were the worst performers. In AUD terms, the Global Small Cap sector rose 5.7% and Emerging Markets (NR) rose 7.8%.

Over the December quarter, the NASDAQ returned 6.3%, the S&P 500 Composite Index returned 6.6% and the Dow Jones Industrial Average returned 11.0%, all in USD terms. European markets experienced mild positive growth across the board, with the FTSE 100 United Kingdom (UK) up 5.0%, the DAX 30 (Germany) up 0.7% while the CAC 40 (France) remained flat over the period. Majority of equity returns were positive across Asia; as the Japanese TOPIX returned 8.7%, the Indian BSE 500 up 10.2%, and the Hang Seng Index returning 8.8%, while the SSE Composite (China) returned -1.2%.

Global and Domestic property experienced positive results over the December quarter. Domestic Real Estate Investment Trusts (REITs) were up 7.8%, while Global REITs increased by 3.9% on a fully hedged basis. The unlisted property sector rose 2.9% over the quarter on a one-month lagged basis. Meanwhile, Global Core Listed Infrastructure 50/50 index increased 2.1% for the quarter in hedged terms.

Global sovereign bonds produced moderate returns over the December quarter for hedged Australian investors. Ten-year bond yields increased in the US (+9 basis points (bps) to 2.41%) and decreased in the UK (-17bps to 1.23%), Japan (-2bps to 0.05%), and Germany (-4bps to 0.42%). Two-year bond yields increased for the US (+40bps to 1.88%) and Germany (+8bps to -0.66%) but fell in Japan (-2bps to 0.14%) and remained relatively flat in the UK (0.45%). Global Bond indices increased, with the Barclays Capital Global Aggregate Bond Index returning 0.9% and the Citigroup World Government Bond (ex-Australia) Index returning 0.8% over the quarter, both on a fully hedged basis.

Domestically, Australian 10-year bond yields decreased 21bps to 2.63% while five-year (-4bps to 2.34%) bond yields also decreased and two-year (+3bps to 1.99%) bond yields increased. Bloomberg Ausbond indices were positive over the quarter, with the highest being Bloomberg Ausbond Inflation index, returning 2.6%. The Bloomberg Ausbond Composite Bond index returned 1.4%.

The AUD depreciated against major currencies over the December quarter, finishing at US$0.782 with a Trade Weighted Index of 64.9. It depreciated 0.3% against the USD, 0.4% against the Yen, 0.8% against the Pound Sterling and 1.9% against the Euro. On a trade-weighted basis, the local currency decreased 2.0% over the quarter.

The S&P GSCI Commodity Total Return Index increased 10.3% over the quarter. Gold prices finished the quarter at US$1,303.46 per ounce for a 1.5% rise over the period. The oil price increased over the December quarter, by 15.7% to $66.61 per barrel. Iron Ore prices increased over the December quarter, to $74 per metric tonne for a 20.2% increase.

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