August/September 2008
Outlook for investment markets
The key event of the past month was the falling world oil price, which supported sharemarkets everywhere. The main influences from here will be lower interest rates after an interest rate cut; relatively subdued local economic activity; and mixed conditions overseas (weak developed but stronger developing economies), and ongoing credit crisis uncertainties.
Australian cash & fixed interest - review
Short-term interest rates dropped smartly over the past month, 90-day bank bills coming down 0.50 percent to 7.30 percent. There were similar declines in longer-term rates. The average yield on corporate bonds dropped 0.70 percent to 8.30 percent, and swap rates - the base for much corporate borrowing - came down by 0.80 - 0.90 percent (for three- to five-year swap funding).
Australian cash & fixed interest - outlook
The Reserve Bank has announced that it is now on an easing course, given the faster-than-expected slowdown in the economy, and that it is prepared to 'look through' the short-term rise in inflation from petrol prices. Short-term interest rates will continue to fall, the futures market currently expecting 90-day bank bills to be 0.70 percent lower by mid-2009 (equivalent to three 0.25 percent interest rate cuts). Longer-term rates should also continue to fall, but there remains the proviso that a further eruption of credit crunch jitters could jeopardise or even reverse the trend.
Australian Property - Review
The devastation sweeping the listed property sector has finally relented, at least temporarily. Prices hit rock bottom on 15 July, but have recovered significantly since then, with an 11.50 percent gain over the past month. This rally has to be seen in the context of the previous awfulness, however: prices are still down 37.70 percent over the past year.
Australian Property - Outlook
It is possible that the listed property sector has, at long last, bottomed out. Traditional valuation yardsticks suggest that a great deal of the sector's problems are already factored into prices. There are wide discounts to net assets, and substantially higher yields of over eight percent across the whole sector. These are even higher for less favoured names: the yield on the Babcock & Brown Japan Trust (which reported during the past month) is over 15.0 percent. But it is still not obvious that the sector is now in the clear. Significant questionmarks remain about further writedowns in net asset valuations, especially in overseas markets such as US offices and European retail properties, and current promised yields may not eventuate if today's dividends are cut as trusts become restricted to paying dividends out of cashflow. All this means that the jury is still out for the listed property sector.
Australian Equities - Review
The S&P/ASX200 Accumulation Index is up three percent over the past month. This rather overstates the true picture, though, which is that the market is essentially trading sideways after bottoming out in mid-July. There is still no clear evidence of a sustained upwards trend from those July lows.
The Industrials have fared rather better over the month (+4.90 percent) than the Resources (-1.10 percent), which have been affected by weaker world commodity prices. Profit results from the Commonwealth Bank and Westpac relieved some of the earlier nervousness caused by ANZ and National Australia Bank's provisions for sub-prime and other exposures. It has been a very mixed month at an individual company level, ranging from record profits and an increased dividend at BHP Billiton at one end, to the ongoing debt crisis fallout at Babcock & Brown and its Power unit in particular at the other.
Australian Equities - Outlook
Some of the domestic economic news has been on the dispiriting side, notably weaker business confidence and (especially) retail sales, which fell more sharply in June than forecasters had expected. Households and firms have been wilting under the combined effects of slower growth in exports, the credit crunch, high interest rates, an uncompetitive $A, expensive housing affordability, and of course petrol bills. That said, Australia remains in better shape than some of the flirting-with-recession major economies. The labour market has held up well, resource prices even after recent weakness are still well up on a year ago, and both interest rates and the $A are becoming less adverse.
The Australian sharemarket may therefore have done enough to discount the bad news.
International Fixed Interest - Review
Government bond yields were steady in the US, but dropped slightly in Japan, and rather more so in Europe. Yields on corporate bonds did not follow government yields down, as credit worries continue to bother investors. The average yield on US corporate bonds, for example (on The Economist's calculations) was slightly higher over the past month, at just under six percent. Bond markets remain either very expensive or outright closed to low credit quality firms.
International Fixed Interest - Outlook
The fall in government bond yields in Europe and Japan is readily-explained by a weakening economic outlook, with (for example) growth in the Eurozone declining 0.20 percent in the June quarter. A reduced fear of permanently higher inflation, as oil and other commodity prices have dropped, also played a part, as did ongoing safe haven demand for government bonds as the credit crisis continues. Although these lower yields have generated modest capital gains on government bonds, they have been offset by capital losses on corporate bonds as corporate credit spreads have widened. The asset class continues to underperform cash and local bonds: the average net return from world bond funds over the six months to 31 July was only 0.60 percent.
International Equities - Review
World shares hit a low point on 15 July, but have since rallied by 5.50 percent. Because of the $A's fall over the period, world shares in $A terms returned 10.10 percent for the past month, although this still leaves a substantial fall over the past year of 18.80 percent. The larger developed markets tended to show mostly small gains. In the US, the S&P500 Index was up 1.40 percent, as was Europe, where the MSCI Europe Index was up 1.90 percent. The emerging markets were weaker, especially the Chinese market, where the Shanghai Composite Index lost 16.50 percent during the month, and is now worth 38.0 percent of its peak value.
International Equities - Outlook
The recent rise in world share prices was the result of several cross-currents. On the positive side, the sharp fall in the oil price appears to have trumped other, more negative developments. Oil dropped sharply from its peak US$145/barrel (West Texas grade) in early July to its current US$114. This reduced pressures on consumer budgets and corporate costs in the developed world, as did falls in world food prices and other commodities. (The Economist's index of world food commodities has dropped 11.70 percent in $US terms over the past month alone.) But there have also been more worrying developments. The credit crisis has continued to prey on investors' nerves, bad news emerging or rumoured at (among others) JP Morgan Chase, Lehman Brothers, insurer AIG, and the US mortgage firms Fannie Mae and Freddie Mac. News out of the developed markets has also been mostly on the disappointing side. GDP in the Eurozone, for example, fell by 0.20 percent in the June quarter, the first time there has been a continent-wide decline since the 1992 - 93 recession. Japan's economy also contracted (by 0.60 percent).
Forecasters are also revising down likely growth in the developing world, although even on more pessimistic readings China and India will still be giving strong support to world trade.
A "wait and see what happens" attitude to international shares remains a sensible approach to
navigating these cross-currents.
Performance periods refer to the month and three months to 21 August 2008.
Source: Morningstar
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