March saw the Australian share market finish in positive territory, putting an end to the consecutive monthly falls experienced in January and February, with the ASX200 Index posting a +4.1% gain. While the index is still down for the calendar year, the result, spurred on by a positive February company reporting season, shows that the domestic economy may be starting to successfully manage its transition away from a dependence on commodities towards a more services based economy. GDP data out during the month showed growth on an annualised basis for the Dec quarter at 3% vs expectations of 2.5%, and NAB’s business confidence survey recorded its highest level since 2012, both supportive of this.
The graph below shows that Australian non-mining activity is growing at an impressive rate:
Of course as is always the case with markets, good news can come with its own set of implications. The stronger than expected economic data helped put upward pressure on the AUD, which gained 7.2% during the month, with the currency now trading at close to $0.76USD. A higher AUD may create some headwinds for Australian exporters and companies with offshore earnings, which is something the RBA will be watching closely over the coming months when deciding on future interest rate moves. Further exacerbating the higher AUD is the increasingly “dovish” approach of the US federal reserve to further US interest rate rises, which shows that some concerns around the rate of global growth remain.
Performance of the ASX200 Index over the 12 months to March 2016 :
Respite in Commodities but nervousness in Banks
Perhaps the biggest surprise of the month was the strong performance of commodities prices, with Iron Ore and Oil posting gains of +8.3% and +7.8% respectively. This in turn had a positive impact on mining stocks, with BHP mirroring the Iron Ore gain, finishing up +8.3% in March. Despite this, we still remain cautious on the sector and feel that much of the gains have been driven by seasonal factors and temporary supply constraints, rather than a turning of the cycle. This is evidenced by a subdued Baltic Dry Index, which measures commodities shipping levels.
Banking stocks had a relatively volatile month for a usually stable sector, as the sustainability of growth in the Australian housing market is increasingly questioned. Rising bad and doubtful debts recorded by the banks, at this stage mostly related to the resources sector, also weighed.
While downside risks remain, equites do not appear over-valued when looking at traditional earnings multiples. The Australian share market is currently trading on a Price/Earnings multiple of 14.7 times estimated 1 year forward earnings, which is more or less exactly in line with its average “fair value” during the low inflation era. Therefore any further sustained weakness would need to be accompanied by either an offshore driven crisis, or significant downgrades to domestic company forecast earnings, the latter looking unlikely given the recent positive readings on the economy. Furthermore in the low interest rate environment company dividend yields on stocks in the ASX200 are significantly higher than what is available in terms of income from other asset classes, including property, as shown in the graph below. This does not take into account the franking credits also associated with Australian shares, which provide an additional benefit.
In terms of international shares the outlook is still relatively positive, despite the rising volatility. As is the case in Australia, low returns on cash and bonds globally mean investors are being forced into equities in order to generate returns, which is supportive of prices. As far as underlying economic fundamentals go, while global growth concerns remain, the US recovery is continuing which should take up much of the slack from a slowing China. Also the US Federal Reserve’s willingness to implement US interest rate rises slowly should help strengthen the US recovery, as well as ease recent currency pressures on China, which pegs its Yuan to the USD. The stabilisation of the Chinese share market is also a positive.
The one concern we do have with international shares is the effect of the rising AUD, which negatively impacts returns in Australian dollars. We have now therefore “hedged” a large portion of client portfolio international share exposure from a currency perspective. This will reduce the negative effect of the rising AUD on returns.
Lastly, in regards to Bond markets, we remain cautious on the outlook for global bonds given the record low interest rates resulting from central bank stimulus programs. However for Australian bonds we think the outlook is more positive, given their higher relative yield vs global peers and the scope for further interest rate cuts by the RBA. In addition the asset class provides important diversification benefits to equities during times of market volatility.
If you would like to discuss this note, or have any other queries, please do not hesitate to give myself or Paul a call.
Glen Holder, BCom, DipFP, CA, MAppFin
Director – Investment Management