Investment commentary - 31 October 2014


Provided by Mercer. The information in this article does not necessarily reflect the views of the Trustee.

Markets started October on a soft note, with risk assets selling off and volatility rising as concerns regarding deflation or low inflation and soft growth in Europe, Japan and China, plus the spread of Ebola weighed on sentiment.

However, markets rebounded in the second half of the month, following positive US economic data and higher than expected earnings from United States (US) listed companies. Equities were also supported by an unexpected announcement on the last day of the month that the Bank of Japan (BoJ) would substantially increase the size of its asset purchase program, and lengthen the maturity of its Government Bond holdings.

Meanwhile, the US Federal Reserve (Fed) concluded the purchase of government bonds and mortgage backed securities this month, finishing the tapering program it started last year - a move widely anticipated by the market.

The latest national accounts data revealed strong momentum in the US economy as real gross domestic product (GDP) rose at an annualised pace of 3.5% in the September quarter, slightly above the market's expectation of 3.0%. The BoJ surprised markets announcing that it will increase the size of its asset purchase program, to an annual pace of ¥80 trillion; ¥10-20 trillion more than previous, and an increase to the target maturity range of its Government Bond holdings by three years to seven years to 10 years. The BoJ will also triple the pace of its equity ETF and Japanese real estate investment trusts (J-REIT) purchases to around ¥3 trillion and ¥90 billion respectively.

The European Central Bank (ECB) left monetary policy unchanged, but provided further detail on its asset purchase program, indicating the program will commence in October and last for two years.

Locally, the Reserve Bank of Australia (RBA) left interest rates on hold at 2.5% in November and retained a neutral bias.

Significant developments

  • The RBA board left the cash rate on hold at 2.5% at its November meeting, retaining a neutral bias. There were no material changes to the accompanying statement with the RBA continuing to express a view that despite the depreciation of the Australian dollar over recent months, that it remains "above most estimates of fair value".
  • October Labour Force data indicated that seasonally adjusted employment increased by 24,100 in October, ahead of consensus estimates for a 20,000 gain. Full time employment increased by 24,100 while part time employment decreased by 9,400. The seasonally adjusted unemployment rate was confirmed at 6.2%. The trend estimates were less positive, with employment increasing 1,300, while the unemployment and participation rates were confirmed at 6.2% and 64.6% respectively. A statement released by the Australian Bureau of Statistics (ABS) two days ahead of the regular Labour Force release indicated that a review of recent seasonally adjusted data had been completed. The result of the review indicated that in September seasonally adjusted employment was 6,000 places higher than indicated by the unadjusted data released in October, while seasonally adjusted employment over the June to August period was revised lower by 21,800 places, indicating that the labour market is slightly softer than previously estimated. Unemployment was revised higher to 6.2% in September from prior estimates of 6.1%.
  • Australian October retail trade data was released, indicating that retail sales surged by 1.2% month-on-month in September, with the release of the iPhone 6 strongly supporting electrical and electronic goods retailing, accounting for 0.6ppts of the headline increase in sales. Cafes, restaurant and takeaway sales increased 2.0%, while
    department store sales rose 1.3%.
  • The consumer price index (CPI) rose 0.5% in the September quarter, slightly ahead of expectations for a 0.4% increase as declines in utility prices (due to the removal of the carbon tax) were smaller than expected, while fruit prices were higher than expected. The CPI rose 2.3% from a year earlier, in line with expectations, and slower than the prior quarter 3.0% pace. Non-tradable inflation rose 0.5% in the quarter and 2.4% over the year, while tradable inflation rose 0.3% in the quarter and 2.0% over the year. Within the quarter food (+1.2%) and alcohol and tobacco (+1.1%) rose the most, while communication (-1.4%) and clothing and footwear (-1.1% declined the most).
  • The Fed's Federal Open Market Committee (FOMC) met in October and ended its QE3 asset purchase programme, lowering the pace of monthly purchases of Treasury Bonds and Mortgage Backed Securities from $15b to nil, as widely anticipated. The statement which accompanied the decision was interpreted as hawkish, with the FOMC indicating that labour underutilisation has further diminished, while no comments were made on soft economic conditions outside the US, or recent market volatility, which some analysts had expected. Nevertheless, the statement continued to indicate that interest rates would remain unchanged for "a considerable time".
  • The first estimate of Q3 GDP indicated that the US economy grew at an annualised pace of 3.5%, ahead of estimates for 3.0%, though slower than the 4.6% annualised growth recorded in Q2. Personal consumption contributed 1.2ppts,
    investment 0.2ppts, government expenditure 0.8ppts and net exports 1.3ppts to growth while inventories detracted 0.6ppts. The large contribution from government expenditure was primarily due to defence spending, so extracting for this, the release was broadly in line with estimates and indicative of US growth in a moderate but comfortable range.
  • US Non-Farm Payrolls rose by 214,000 in October, below expectations for 235,000. September payrolls were revised from 248,000 to 256,000 and August Payrolls from 180,000 to 203,000. The unemployment rate declined from 5.9% to 5.8%, with both short term and long term unemployment declining, while the participation rate increased from 62.7% to 62.8%. Earnings increased 0.1% in the month to be 2.0% higher than a year earlier. The soft pace of wages growth is somewhat surprising given the low levels of unemployment.
  • The Institute for Supply Management® (ISM) Manufacturing Index rose to 59 in October from 56.6 in September, exceeding expectations for 56.1, while also indicating the strength of the US manufacturing sector. The increase was primarily driven by increases in New Orders, though other sub-indices such as Backlog of Orders and Employment also contributed to the improvement in the data.
  • The BoJ caught the market by surprise, by increasing the size of its asset purchase programme in October in an effort to push inflation towards its 2.0% target. The BoJ will seek to increase the size of the monetary base at an annual pace of ¥80 trillion, ¥10-20 trillion more than before and increase the target maturity range of its JGB holdings by three years to seven years to 10 years. The BoJ will also triple the pace of its equity exchange traded funds (ETF) and J-REIT purchases to around ¥3 trillion and ¥90 billion respectively.
  • Chinese GDP rose 7.3% year-on-year in September, slightly ahead of expectations for 7.2%, but slower than the 7.5% growth recorded in the year to June. Chinese GDP growth was the slowest recorded since Q1 2009. The 1.8ppt contribution to growth from Investment was slower than in prior quarters, clearly negatively impacted by a slowing housing market, though from a longer term perspective, this is a positive development, consistent with government objectives to rebalance the economy from investment to consumption driven growth. On the other hand, given the strong 2.8ppts contribution to growth from net exports, domestic demand only contributed 4.6ppts to GDP growth, indicative of the recent softening of growth in China.
  • The HSBC China Manufacturing purchasing managers' index (PMI) increased slightly to 50.4 in October from 50.2 in September, due to an increase in the employment component, though this was partially offset by the output and neworders sub-components declining. Meanwhile the Official Manufacturing PMI declined to 50.8 from 51.1 in October, and fell short of expectations for 51.2. Output, new orders and new exports orders all declined.
  • The ECB met in early November and left monetary policy on hold. Nevertheless markets welcomed the increased transparency provided by the ECB, which indicated that it will use its asset purchase program to increase the size of its balance sheet to what it was at the beginning of 2012, an implied increase of approximately €1 trillion.
  • The extent of the task at hand for the ECB to prevent deflation taking hold was evident in the release of Euro Area CPI, which decreased to 0.3% year-on-year in September, unchanged from August, though widely anticipated by markets. Core CPI, which excludes volatility items, increased 0.8% year-on-year, ahead of expectations for 0.7%, though behind the 0.9% increase recorded in August.


Australian equities

Australian Equities rose in October with the S&P/ASX 300 Accumulation Index returning 4.3%. Financials ex-Property Trusts (+6.9%) and Property Trusts (+6.5%) were the strongest performing sectors, while Energy (-3.7%) and Materials (-0.3%) were the weakest sectors. Australian small caps underperformed Australian large caps, with the Small Ordinaries Accumulation Index returning -0.5%.

Global equities

Global Equities returned 1.3% in hedged ($A) terms and 0.1% in unhedged (A$) terms, as the Australian dollar appreciated during the month. Global small caps returned 1.3%, while emerging markets returned 0.7% (both in A$ unhedged). In the US, the S&P500 returned 2.3%, while the NASDAQ returned 3.1%. Outside of the US, Hong Kong (+4.6%) and Japan (+1.5%) were strong performers, while Italy (-5.3%) and France (-4.1%) were weak performers (returns in local currency terms). Utilities (+3.5%) and Healthcare (+2.0%) were the strongest performing global sectors, while Energy (-5.5%) and Materials (-3.9%) were the weakest (all in US$ terms). Among emerging market shares Turkey (+7.5%) and Russia (+5.5%) were strong performers, while Korea (-2.8%) and Greece (-2.3%) were weak (returns in local currency terms).

Property and infrastructure

The real assets sector performance was generally positive October, with global listed infrastructure returning 4.0% and global listed property returning 7.3% (in A$ hedged terms). Agricultural commodities returned 8.8% while Broad Commodities returned -0.8% (both in A$ hedged terms).

Fixed interest

Ten-year sovereign bond yields declined in the US (-17bps to 2.33%), UK (-6bps to 2.25%), Germany (-6bps to 0.84%) and Japan (-6bps to 0.46%). Two-year bond yields decreased in the US (-9bps to 0.47%), UK (-18bps to 0.66%) and Japan (-4bps to 0.03%) and increased in Germany (+1bp to -0.05%). Australian yields declined across the curve, with the two-year (-11bps to 2.55%) five-year (-16bps to 2.81%) and ten-year all decreasing (-20bps to 3.29%). As a result, global sovereign bonds returned 1.1% ($A hedged) and Australian sovereign bonds returned 1.2%, global credit returned 1.0% (A$ hedged) and emerging markets debt returned 1.1% ($A unhedged).


The A$ appreciated 0.6% against the US$ in September, holding ground following its significant depreciation in September. The US$ appreciated 2.4% against the Japanese Yen and 0.8% against the Euro. The A$ appreciated 3.0% against the Japanese Yen and 1.4% against the Euro, to end the month 0.7% higher on a trade-weighted basis.


Commodity prices were generally weaker in October. The broader S&P GSCI Commodity Total Return Index fell by 6.4% for the month of October. Gold prices fell 3.9%, finishing the month at US$1,165.69 per ounce and the oil price fell by a further 10.8% to US$84.45 per barrel. Iron ore prices rose by 3.2% to US$81 per metric tonne.

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