Recent Events & Possible Outcomes: Local & Global Financial Markets

Recent Events & Possible Outcomes: Local & Global Financial Markets

The Global Economy

  • US recovery underway with improvement in jobs, consumer sentiment, housing, and industrial activity
  • US Federal Reserve signals low rates until 2014 to encourage growth
  • UK enters double dip recession ahead of Olympics
  • Greece reaches deal with creditors
  • European Central Bank helps Europe refinance €529b in loans
  • China GDP growth eased to 8.9% from 9.1%

Since the beginning on 2012, the tentative global economic recovery has gathered pace. The U.S economy is improving ahead of elections later this year, and assurances that interest rates will remain low – or effectively close to zero – until late 2014 has given a boost to domestic confidence.

In Europe, Greece reached a voluntary deal with creditors to swap their current holdings of Greek bonds for new bonds with later maturity dates and lower returns. This enabled the Greek government to write off around €100 billion of its debt, and paved the way for a €130 billion bailout package by international lenders (which is still reliant on the implementation of austerity measures).

Spain is also attracting more attention given a recent cut to its credit rating, which is now BBB+, after the country slipped into its second recession in three years. The Government is pushing through budget cuts to reduce its debt, but this does little to address the country’s 24% unemployment rate (one of the highest rates in the developed world).

The Spanish government has already rescued a number of banks that were too exposed to a decade-long construction boom that crashed in 2008. Whilst the country’s banks will likely continue to require financial assistance from the government, the market does not expect Spain to default on its government issued debt like Greece did.

In Asia, China’s annual economic growth slowed to below 9% for the first time in a decade. (This has led to lower share prices amongst many Australian resource stocks). However, financial markets have been anticipating a slowdown for some time, due to lower demand for China’s exports and the government’s attempt to curb the growth of domestic house prices.

The Australian Economy

Australia’s economic growth is actually slowing below long term averages at a time when many developed countries are growing. The high Australian dollar is curbing domestic activity, as it makes our exports less competitive overseas.

Australia’s inflation rate is now trending below the Reserve Bank’s 2% to 3% range, which contributed to today’s 0.50% interest rate cut. This is the biggest cut since the GFC and reflects the fact that the positive effects of the mining boom aren’t flowing through to all sectors of the economy. The market is anticipating interest rates will fall by a further 0.5% over the next year. This will reduce rates for cash accounts and term deposits, and reinforces the importance of our global, variable maturity fixed interest strategy.

Mining related activity continues to receive extraordinary levels of investment, whilst manufacturing, tourism, retailing and other sectors continue to struggle. Lower interest rates, higher consumer confidence and a lower Australian dollar would be the likely impetus for these sectors to turnaround.

The Federal Government’s focus on returning the budget to surplus appears difficult due to a fall in tax revenue from the softening economy. A politically driven budget surplus in an attempt to demonstrate economic responsibility may not be what the Australian economy needs at the present time.

Some policies may be announced in the Federal Budget on 8 May aimed at increasing government revenues – we will provide a summary of key elements of the budget and their potential impact on our clients next week.

Financial Markets Overview

  • Q1 2012 was the best quarter for global equity markets in 14 years (this confirms the benefits of diversification and discipline)
  • “Risk On” climate boosted small stocks, value stocks and emerging markets
  • Strong rebound in financials globally after poor 2011
  • Australia lagged due to high $A and slowing economy

The graphics below shows the returns of various asset classes to 31 March 2012.

 

 Recent Events & Possible outcomes: local & global financial markets (1)

Recent events & possible oucomes: local & global financial markets (2)

Source: Returns Program

In the second half of 2011, investor fears drove the Australian and global stockmarkets down by 10%. With the worst fears not being realised, risk appetites rebounded in the March quarter. The MSCI World index (a proxy for global stockmarkets) posted its best quarterly performance in 14 years. As can be seen below, all developed markets produced positive returns except for Spain:

 Recent events & possible outcomes: local & global financial markets (3)

Within equity markets, there were strong performances from small stocks, emerging markets and value stocks.

The MSCI emerging markets index posted its best first quarter performance in 20 years. Some of the countries that lagged in 2011 were among the best gainers.

Compared to developed and emerging markets, Australian shares lagged, although still posted their best quarter since September 2009.

With the local economy softening, earnings downgrades outpaced upgrades. Miners lagged the broader market on signs of slower growth in China, while banks marginally beat the index. The main drag came from defensive consumer staples and telecommunications.

Appetite for yield again boosted real estate investment trusts (REITs) – the asset class hit hardest by the GFC. This sector in general was successful in dealing with its capital management issues, reducing gearing easing and improving asset quality. In the US, the stronger economy and growing occupancy rates boosted office and commercial REITs.

With risk appetites reawakening, returns from fixed interest lagged those of shares. Nevertheless, they still were positive. While in 2011 the demand was for the highest rated government bonds, attention has now shifted to corporate debt.

Small companies were the best performing asset class globally in the March quarter and Australia was no exception. It was a quarter when our strategy of targeting small and value stock premiums delivered good returns.

Author: Rick Walker

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Note: This material is provided for information only. No account has been taken of the objectives, financial situation or needs of any particular person or entity. Accordingly, to the extent that this material may constitute general financial product advice, investors should, before acting on the advice, consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation and needs. This is not an offer or recommendation to buy or sell securities or other financial products, nor a solicitation for deposits or other business, whether directly or indirectly.