Investment commentary - 31 December 2014



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

December 2014 wrapped up an eventful year in financial markets with the key issue being a dramatic fall in oil prices, with oil ending at almost half the price of where it had started the year.

At the close of December, overseas shares returned -0.7% in hedged terms and 2.6% in unhedged terms, supported by the fall in the Australian dollar. Australian equities had a positive month in December, however, continued to lag global equities as the slump in commodity prices weighed concerns about the impact on the economy.

Major government bond yields continued to fall over the month, with 10-year yields reaching lows last seen in mid-2013.In the United States (US), the Federal Reserve (Fed) continues to foresee growth in the US economy, revising up its growth forecast for 2014 (2.3% to 2.4% from 2.0% to 2.2% September forecast) and 2016 (2.5-3.0% from the previous 2.6% to 2.9%) while continuing to see growth of 2.6% to 3.0% for 2015, and 2.3% to 2.5% in 2017. While falling oil prices had an impact on lowering the headline consumer price index (CPI), the Fed indicated that this was expected to be temporary.

Lower oil prices are expected to provide a boost to disposable incomes and US consumer spending. Labour market conditions improved further with total non-farm payroll employment rising by 321,000 in November, compared with an average monthly gain of 224,000 over the prior 12 months. Job gains were widespread, led by growth in professional and business services, retail trade, health care, and manufacturing, leaving unemployment rate unchanged at 5.8%. In December, employers added 252,000 jobs and the unemployment rate fell to 5.6%, marking the best year for the job market since the recession began eight years ago.

Retail sales jumped 0.7% in November - the highest gain in eight months - in line with an improving labour market and lower oil prices. US manufacturing purchasing managers' index (PMI) fell from 54.8 to 53.7 in December, the lowest level since early 2014. However, it remains well above the 50 mark, signalling an expansion in manufacturing activity. Meanwhile, in the Euro zone, preliminary estimate of 2014Q3 growth was confirmed at 0.2%, while inflation slowed from 0.4% to 0.3% and unemployment remained high at 11.5% in November.

The European Central Bank (ECB) continues to press ahead with large-scale government bond purchases to obviate the risk of deflation and weak economic growth becoming entrenched in the region. Japan continues to disappoint with the second release of Q3 national accounts downgraded from an already weaker than expected -1.6% to -1.9%. In Australia, confidence faltered with weaker than expected gross domestic product (GDP) growth in Q3.

The trend unemployment rate increased from 6.2% to 6.3%, while the participation rate was unchanged at 64.6%. The Australian dollar dropped 4.1% against the US dollar finishing at $0.818 for the month, its lowest level since mid-2010. Over the year, the Australian dollar fell 8.5% against the US
dollar and 3.5% against the trade weighted index.

Significant developments

  • Australian seasonally adjusted employment rose by 42,700 in November, ahead of expectations for 15,000; however, October's 24,100 gain was revised down to 13,700. 40,800 of the job gains were part time. Unemployment rate increased from 6.2% to 6.3%, while the participation rate was unchanged at 64.6%. Trend employment increased by 7,100, with an 8,800 increase in part time employment more than offsetting a small loss in full time employment. The trend unemployment rate increased from 6.2% to 6.3%, while the participation rate was unchanged at 64.6%.
  • Australian retail trade rose 0.1% in November, falling short of expectations for a 0.2% rise, though following strong monthly rises of 0.4% in October and 1.3% in September. In trend terms, department stores (+0.6%), household goods and clothing, footwear and personal accessories (both +0.5%) were the strongest sectors, while other retailing (-0.1%) and cafes, restaurants and takeaway (+0.3%) were the weakest sectors.
  • The Government's Mid-Year Economic and Fiscal Outlook was released in December. The expected 2014-15 Commonwealth budget deficit was revised to $40.4 billion (2.5% GDP) from $29.8 billion (1.8% GDP) forecast in the May budget. $6.2 billion of the estimated deterioration is due to lower employment, nominal GDP and iron ore prices flowing through to lower tax receipts. The remainder of the deterioration is due to Federal Parliament not passing some May budget decisions, partially offset by some savings measures.
  • The Fed's Federal Open Market Committee (FOMC) met in December and left monetary policy unchanged, as expected. Nevertheless, the market focus was on the accompanying statement. Despite strengthening economic conditions, the FOMC retained its commitment to keeping interest rates on hold for "a considerable time", while adding that it can be "patient in beginning to normalise the stance of monetary policy". The FOMC also released its quarterly economic projections, which made downward revisions to its unemployment and inflation forecasts, while the median FOMC member's interest rate target for each calendar year end was also lowered.
  • US Non-Farm Payrolls increased by 252,000 positions in December, ahead of expectations for 240,000, while the October and November payrolls were revised higher by 50,000. The unemployment rate decreased from 5.8% to 5.6%, also ahead of expectations for 5.7%, while the participation rate declined from 62.8% to 62.7%. While the employment data was positive, markets were disappointed by slow wage growth. Average earnings declined by 0.2% in December, well short of expectations for a 0.2% gain, while November earnings were revised downwards to 0.2% from 0.4%. Earnings increased 1.7% over the calendar year, quite slow considering the substantial increase in employment and declining slack in the labour market.
  • The final estimate of Q3 US GDP was revised up from 3.9% to 5.0% quarter-on-quarter (QoQ) annualised, ahead of expectations for 4.3%. Upward revisions were made to personal consumption and private investment, though partially offset by lower net exports. Personal consumption contributed 2.2ppts, fixed investment 1.2ppts, government spending 0.8ppts (mostly defence) and net exports 0.8ppts.
  • The US ISM Manufacturing Index eased to 55.5 in December from 58.7 in November, falling short of expectations for 57.5, though still in expansionary territory. Most sub-indices declined, with the exception of supplier deliveries and employment. Of the 16 industries covered 11 in the survey reported growth, down from 14 in November.
  • US Retail Sales rose 0.7% month-on-month (MoM) in November, ahead of expectations for 0.4%, while October sales were revised up from 0.3% to 0.5%, another indication that higher employment is having a positive impact on consumer spending. Retail Sales excluding Autos and Gasoline rose 0.6%, ahead of expectations for 0.5%.
  • The US CPI declined 0.3% in November, from a flat October reading and was below expectations for a 0.1% decline. The CPI rose only 1.3% from a year earlier, while Core CPI rose 1.7%, with the difference arising largely due to significant energy price declines in recent months.
  • The HSBC China Manufacturing PMI declined to 49.6 in December from 50.0 in November. Meanwhile the Official Manufacturing PMI declined to 50.1 from 50.3, though was slightly ahead of expectations for 50.0. New orders, output, inventories, employment and input prices all decreased, with only export orders improved relative to November.
  • Euro area CPI is estimated to have fallen 0.2% in 2014, falling short of estimates for -0.1%, and 0.3% inflation recorded over the year to November, primarily due to falling energy prices. Core inflation, which excludes energy, food, alcohol and tobacco rose 0.8% over the year, slightly ahead of expectations of 0.7%.
  • In late December, the Japanese government announced a JPY 3.5 trillion (AUD 36 billion) stimulus package in response to negative growth in the second and third quarters. The package includes granting of shopping vouchers to consumers, low interest financing for businesses, support for regional areas and areas impacted by natural disasters. The government expects the package to raise GDP by 0.7%.
  • The Russian Central Bank dramatically raised interest rates from 10.5% to 17.0% to halt the rapid decline in the Rouble and substantial capital outflows, while limiting high inflation. The Russian economy has been hit hard by a combination of tumbling oil prices and economic sanctions by the US, European Union and other large economies in retaliation for Russia's actions in Ukraine.


Australian equities

Australian equities rose in December with the S&P/ASX 300 Accumulation Index returning 2.0%. Across the market cap spectrum, large cap returned 2.0% meanwhile small caps returned 0.5%. Industrials (+5.9%) and Healthcare (+5.6%) were the strongest performing sectors, while Consumer Discretionary (-2.2%) and Energy (-1.7%) were the weakest sectors.

Global equities

Global equities returned -0.7% in hedged (Australian dollar) terms and 2.6% in unhedged (Australian dollar) terms, as the Australian dollar continued to depreciate during the month. Global small caps returned 4.9%, while emerging markets returned -0.5% (both in unhedged terms). In the US, the S&P500 returned -0.3%, while the NASDAQ returned -1.2%. Outside of the US, China (+20.6%) was a strong performer, while Hong Kong (-1.6%) and the UK (-2.3%) were weak performers (returns in local currency terms). Utilities (+4.2%) and Consumer Discretionary (+3.8%) were the strongest performing global sectors, while Telecommunication Services (-1.5%) and Healthcare (1.7%) were the weakest performing sectors.

Property and infrastructure

The performance of the real assets sector was positive in December, with global listed infrastructure returning 4.2% in unhedged terms and global listed property returning 1.5% (on a fully hedged basis). Domestic Real Estate Investment Trusts (REITs) returned 4.3% in December while Australian direct property returned 0.5% in November 2014.

Fixed interest

Ten-year sovereign bond yields declined in the US (-2bps to 2.17%), UK (-17bps to 1.76%), Germany (-14bps to 0.54%) and Japan (-9bps to 0.33%). Two year bond yields increased in the US (+17bps to 0.63%) but decreased in the UK (-7bps to 0.45%), Japan (-2bps to -0.02%) and Germany (-6bps to -0.07%). Australian yields declined across the curve, with the two-year (-25bps to 2.18%) five-year (-30bps to 2.27%) and 10-year all decreasing (-22bps to 2.81%). As a result, Australian sovereign bonds returned 1.7%.


The Australian dollar depreciated -4.1% against the US dollar in December. The Australian dollar fell against most major currencies including -1.1% against the Euro, -2.5% against the Pound Sterling and -2.4% against the Japanese Yen. On a trade weighted basis, the local currency lost 2.5% over the month.


Commodity prices continued to weaken in December. The broader S&P GSCI Commodity Total Return Index fell by 9.9%. The price of oil dropped by a further 20.9% to US$56.90 per barrel, falling just shy of a 50% drop over the year. Meanwhile, gold prices rose marginally by 0.37%, finishing the month at US$1,186.33 per ounce. Iron ore prices rose slightly by 2.9% to US$72 per metric tonne.US Retail Sales rose 0.7% month-on-month (MoM) in November, ahead of expectations for 0.4%, while October sales were revised up from 0.3% to 0.5%, another indication that higher employment is having a positive impact on consumer spending. Retail Sales excluding Autos and Gasoline rose 0.6%, ahead of expectations for 0.5%.


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