By CHRIS RYLANDS
PRINCIPAL, WEALTH ADVISORY
Chris.Rylands@williambuck.com

Cash 

The March quarter inflation figures, released late in April, showed an unexpected drop in prices of -0.2% for the quarter and 1.3% year on year. The latter reading was well below the Reserve Bank of Australia’s (RBA) target range of 2 – 3%. 

The largest declines came from the retail, food and transport sectors. Intense rivalry between domestic and offshore retailers, combined with lower oil prices were the main contributors to lower prices. The RBA moved quickly to cut the cash rate by 25 bps in May, to a new historic low of 1.75%. 

The RBA noted that accommodative monetary policy has been successful in supporting demand and a lower exchange rate, but resolved a further rate cut was required to support prices and spur economic activity.
At the July meeting, the RBA left the cash rate on hold, citing the need to assess the impact of the May interest rate cut and UK Brexit referendum on the domestic economy.  The June quarter inflation data released at the end of July was also soft, increasing the odds of an August interest rate cut.  As expected, the RBA proceeded to reduce interest rates by 0.25% to record low of 1.50% at its August meeting. 

The divergent path of US and Australian interest rates will likely place renewed downward pressure on the Australian ($A). The $A has been strong recently as the US Federal Reserve delayed raising rates in the lead up to the Brexit vote. However, the domestic interest rate cut in August and the potential for a September increase in the US is likely to see the downward bias reinstated for the $A. 

The highest term deposit rates on offer are currently 2.85%, 2.90% and 3.05% across 3, 6 and 12 months respectively.  We are negotiating directly with term deposit providers on a case by case basis to ensure we secure highest possible interest rate on your behalf. 

Fixed Interest 

Australian and global bonds returned 0.26% and 0.31% respectively in April as yields drifted higher. The increase in Government Bond yields was driven by increasing confidence as equity markets bounced higher in March and April from the February lows. 

Australian bonds outperformed global bonds in May as the RBA cut domestic interest rates to a record low of 1.75%. Australian bonds returned 1.26% for the month, largely driven by capital gainsin Government bonds as the yield on the Australian 10 year bond hit a record low.  Global government bonds returned 0.57% for the month as yields fell across the major markets, pushing prices higher.

Australian bonds returned 1.33% in June, with the Australian 10-year Treasury yield falling to a new record low of 1.98% during the peak of the Brexit uncertainty. Likewise, Global bonds returned 1.98% during the month as a result of the flight to safety from equities into bonds.  The performance during June highlighted the sector’s diversification benefits during periods of increased uncertainty.  

Australian Equities 

Australian shares started the quarter stronger, building on the recovery from the February lows. The main drivers of performance were the materials and energy sectors, whilst banking stocks lagged as investors digested mixed earnings results. 

Investors cheered the RBA’s May interest rate cut, with Australian shares moving 2.30% higher on the day of the announcement. Lower rates were supportive of shares, as was the decline in the $A.  Healthcare stocks were the main driver of returns for the month, with investors attracted to the sector’s defensive qualities and offshore earnings which benefit from a falling $A. 

The unexpected Brexit outcome initially sent Australian shares lower during June, as investors grappled with the implications of the UK’s decision.  Financial stocks with direct exposure to the UK and Europe were hardest hit.  Australian equities have since bounced over 7% from the June lows as investors became increasingly confident that Brexit’s global impact would be limited.
   
Attention will now turn to the domestic reporting season which begins to pick up in August. The expectation is for earnings to grow around 9% from the prior period. Approximately half of the growth is coming from the materials and energy sectors, which have enjoyed a strong bounce in earnings in line with recent commodity price strength.   
The post Brexit bounce leaves the Australian market trading on a Price/Earnings (PE) Ratio of 16.4x.  The upcoming earnings results will need to meet expectations to ensure the premium above the long term average of 15.1x is justified in the current market. The dividend yield on Australian equities of 4.5% will continue to lend support to the market given the current cash rate is 1.50%.

 

Source: AMP 

Global Equities 

Global equities were higher during April as global central banks paused in anticipation of upcoming Brexit volatility in June.  The US Federal Reserve (Fed) and European Central Bank (ECB) both kept rates on hold, preferring to keep powder dry for a response to any Brexit fallout.  

US economic data was better than expected in May, lifting US shares by 1.53% for the month and reassuring investors that the US economy could withstand higher interest rates. German shares were also higher as the ECB confirmed it would begin buying Corporates Bonds in an effort to reduce the cost of corporate debt. 

Market falls in the wake of the Brexit vote meant that global equities were significantly weaker in June, with the UK market hardest hit.  The major global markets have also bounced in the weeks post the Brexit announcement, with US and European shares up over 7%. The rebound was helped by verbal support from global central banks, with the Bank of Japan, Bank of England and ECB all hinting at potential intervention to stem market volatility. 

The focus has now turned to the US reporting season which is occurring in the midst of US equities posting a series of new highs.  With the SP500 trading on a PE Ratio of 17x (long term average of 14.3x), earnings will need to meet expectations for these levels to hold in the coming months.  Approximately 68% of reporting companies have so far released earnings above expectations.   

Alternatives Investments (Hedge Funds)

Hedge Fund2 strategies generally struggled with the increase in volatility during April and May. Many commodity and currency markets were lower in April, only to reverse course in May, wrong-footing many strategies. The plunge in many markets during the height of the Brexit volatility was a timely reminder of the diversification benefits of these strategies, with returns of 3 – 8% delivered during the month of June alone. The strategies benefited from the sharp fall in the British pound post the Brexit result and an increase in some commodity prices, primarily gold and silver.

 

1. There is an inverse relationship between the yield on a fixed rate Government Bond and the price. As investors buy Government bonds the price increases resulting in a lower yield and vice versa. 
2. Hedge Funds aim to generate a return by using a number of strategies to take advantage of rising and falling prices across stocks, bonds, currencies and commodities.