Investment commentary - 31 July 2016

 Provided by Mercer. The information in this article does not necessarily reflect the views of the Trustee.
Following the late-June sell off driven by Brexit uncertainty, major equity markets quickly resumed the risk-on episode that encapsulated the months leading up to the vote.

A strong consensus has emerged that the direct economic impact of the vote will be largely confined to the United Kingdom (UK), with only limited spillover into the European Union (EU), and even less to the rest of the world. This rebound meant a strong July MSCI World ex Australia index return of 4.1% for hedged Australian investors.

The S&P 500 returned to levels just shy of record highs, returning 3.9% in terms of United States (US) dollars (USD) over the month of July. Emerging market equities delivered 2.9% in the month (Australian dollar terms), although with considerable dispersion across countries. The Australian market has been among the strongest performing developed economies. The S&P/ASX 300 rose by 6.4% over the month and 7.7% so far in 2016. Australian small caps delivered returns of 8.6% and 16.1% over comparable periods, underpinned by a surging gold sector.  Australian Real Estate Investment Trusts (A-REITs) also continued to perform strongly.

Following the release of a 0.4% Consumer Price Index (CPI) figure for the June quarter and 1.0% over the 12 months to June 2016, the Reserve Bank of Australia (RBA) cut rates further by 0.25% to an all-time low of 1.50%. In his release, Glenn Stevens noted that since the May rate cut, the outlook for output and unemployment has not changed, and confirmed that inflation is likely to remain below 2% over most of the forecast period.



  • The RBA lowered the interest rate in its August meeting, down 25 basis points (bps) to 1.50%.  RBA Governor, Glenn Stevens, noted in his release that Australian growth is continuing despite a large decline in business investment. Inflation remains quite low and is expected to for some time given very subdued growth in labour costs and very low cost pressures elsewhere in the world. Lower interest rates have been supporting domestic demand and a lower exchange rate has helped the trade sector. He noted supervisory measures have strengthened lending standards in the housing market and a number of lenders are also taking a more cautious attitude to lending in certain segments. Dwelling prices have only risen moderately over the past year while growth in lending for housing purposes has slowed a little. This suggests the likelihood of lower interest rates exacerbating risks in the housing market has diminished. This wary but optimistic stance is consistent with previous recent statements.
  • Australian seasonally adjusted employment rose 7,900 in July, behind expectations for 10,000 while June employment was revised up from 17,900 to 19,200. The unemployment rate rose to 5.8%, in line with market expectations. The participation rate also rose to 64.90%, in line with expectations. Part time jobs decreased by 30,600 while full time jobs increased 38,400. In trend terms employment increased by 3,700 while the unemployment rate was flat at 5.7% and the participation rate remained steady at 64.8%.
  • Australian Retail Sales rose 0.1% month on month (MoM) in seasonally adjusted terms over June, behind expectations for 0.3%, following a 0.2% increase in May. The strongest gains were in other (+0.5%) and the weakest was Household goods retailing (0.0%). In trend terms, retail sales rose 3.1% year on year (YoY), down from 3.3% over the year to May.
  • Australian Inflation increased to 0.4% quarter on quarter (QoQ) and 1.0% YoY in Q2, from -0.2% and 1.3%, respectively last quarter. This was in line with market consensus for 0.4% QoQ and slightly below 1.1% YoY. The trimmed mean which excludes volatile items rose 0.5% QoQ and 1.7% YoY, falling outside of the RBA’s 2% to 3% target band, leading to markets pricing in a higher probability of a cut to the cash rate prior to the RBA’s August meeting.
  • US Non-Farm Payrolls increased by 255,000 in July, well above expectations for 180,000 while there was an upwards revision of 5,000 to the prior months employment. The unemployment rate remained at 4.9%, above expectations of a drop to 4.8%, while the participation rate rose to 62.8% from 62.7%. Wages rose 0.3% MoM and remained steady at 2.6% YoY, from 0.1% and 2.6% over the month and year, respectively to July.
  • The Institute for Supply Management (ISM) Manufacturing Index decreased to 52.6 in July, below consensus for 53.0, and 53.2 in June.  Textile Mills, Printing & Related Support Activities and Miscellaneous Manufacturing reported the largest growth while Apparel, Leather & Allied Products and Electrical Equipment were the most significant declines. The ISM Non-Manufacturing Index decreased to 55.5 in July from 56.5 in June, and below expectations for 55.9.  Arts, Entertainment & Recreation and Educational Services were the most significant contributors while Other Services, Agriculture and Forestry were the largest detractors.
  • The initial estimate of Q2 2016 US gross domestic product (GDP) was released. GDP was estimated to have grown 1.2% QoQ annualised, below expectations for 2.50%, and 1.6% growth recorded in Q1 2016.
  • US Headline CPI remained at 0.2% MoM and 1.0% YoY to June, behind expectations for 0.3% and 1.1%, respectively. Core CPI remained at 0.2% MoM in line with expectations and rose to 2.3% YOY above expectations of 2.2% for the month.
  • The China Caixin Manufacturing purchasing managers’ index (PMI) printed 50.6 in July, above expectations for 48.8 and the 48.6 reading in June. Output, new orders and inventory all increased. Meanwhile, the official PMI decreased to 49.9 in July, below expectations of 50.0.
  • Chinese GDP remained at 6.7% YoY to Q2, above expectations for 6.6% and holding at 6.7% recorded over the year to Q1. However, QoQ seasonally adjusted grew 1.8% QoQ, above expectations for 1.6% and the prior 1.2%.
  • European Core CPI estimates held steady at 0.9% over the year to July, from 0.9% in June, ahead of estimates for 0.8%. The unemployment rate remained at 10.1% in June, in line with expectations.
  • The Eurozone composite PMI rose to 53.2 in July, up from 52.9 in June. Germany lifted activity despite stagnation in France and slowdown in Italy and Spain.


The Australian equity market was strong over July, with the S&P/ASX 300 Accumulation Index returning 6.4% for the month. There were positive returns across the market cap spectrum, with the weakest relative performer being the ASX 50, returning 5.8% for the month. The best performing sectors were Consumer Discretionary (+8.9%) and Consumer Staples (+8.6%). The weakest performing sectors were Energy (+0.2%) and IT (+3.9%). The largest positive contributors to the return of the index were Westpac Group, ANZ and CBA, with absolute returns of 6.3%, 7.8% and 4.0% respectively. In contrast, the most significant detractors from performance were Cimic Group, Santos and Origin Energy with absolute returns of -18.0%, -5.4% and -3.9% respectively.


The broad MSCI World ex Australia Index was up 4.1% in hedged terms and 2.0% in unhedged terms over the month, as the Australian dollar appreciated against major currencies over July. The strongest performing sectors were IT (+6.0%) and Materials (+4.5%), while Energy (-4.0%) and Consumer Staples (-1.8%) were the worst performers. In Australian dollar terms, the Global Small Cap sector rose 3.4% while Emerging Markets returned 2.9%.

Over July, the NASDAQ returned 6.6%, the S&P 500 Composite Index returned 3.7% and the Dow Jones Industrial Average returned 2.9%, all in US$ terms. European markets also experienced strong returns, with the FTSE 100 (UK) up 3.4%, DAX 30 (Germany) up 6.8% and the CAC 40 (France) up 4.9%. In Asia, the Indian BSE 500 was up 5.0%, the Hang Seng Index 5.3%, the SSE Composite (China) 1.7% and the Japanese TOPIX up 6.2%.


The Real Assets sector saw broadly positive returns over June with Global Core Infrastructure returning 4.0%, and Global REITs returning 3.1% (both in Australian dollar hedged terms). Domestic REITs posted a return of 3.5% in June to be up 24.6% for the financial year to date, while Australian Direct Property (NAV) returned 0.5% on a lagged basis.


Global sovereign bonds were slightly more muted over July for hedged Australian investors. Ten-year bond yields fell across most developed economies with Germany (-5bps to -0.18%), the UK (-21bps to 0.69%) and the US (-3bps to 1.46%) all experiencing falls. Japan ten-year bond yields rose 6bps to -0.17%. Two-year international bond yields saw marginal rises with the UK (flat at 0.11%), the US (+8bps to 0.66%), Japan (+5bps to -0.24%) and Germany (+2bps to -0.63%) all maintaining or increasing yields. Global Bond indices were positive for hedged investors, with the Barclays Capital Global Aggregate Bond Index returning 0.7% and the Citigroup World Government Bond (ex-Australia) Index returning 0.5% over the month, both on a fully hedged basis.

Domestically, Australian 10-year bond yields fell 11bps to 1.88% while five-year (-9bps to 1.57%) and two-year (-6bps to 1.54%) bond yields also fell. As a result, Australian bond returns were positive for the month. Australia Treasury Bond Index returned 0.9% while the Australian Composite Bond Index returned 0.7% for the month.


The Australian dollar strengthened against most currencies over July, finishing at US$0.760 with a Trade Weighted Index of 63.3 on 31 July 2016. The Australian dollar appreciated against the US dollar (+2.1%), the Euro (+1.4%), the Yen (+2.2%) and the Pound Sterling (+2.9%). On a trade-weighted basis, the local currency rose 1.3% over the month.


In commodities, the S&P GSCI Commodity Total Return Index fell 11.4% for the month. Gold prices finished the month at US$1,349.09 per ounce for a 2.1% rise over the period. The oil price fell over July, by 14.5% to $42.44 per barrel. Iron ore prices rose over the month however, by 11.0% to US$60.5 per metric tonne.
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