31 August 2018
Themes For August
Despite unrest surrounding the on-going global trade saga and problems in emerging markets, most developed equity markets posted respectable gains over the month of August.   Buoyed by a stellar profit reporting season, the US market was up 3.3% led by the large tech names many of which pushed to record highs.   Elsewhere, Asian markets were firmer with Japan up 1.4% and Hong Kong 0.8% higher however mainland China fell 0.6% weighed down by trade concerns. European markets fell 1.9% on renewed concerns about the strength of the Eurozone economy while the UK fell 3% as it continues to struggle to find a workable exit strategy from the EU. The Australian market held up well, advancing 1.4% despite weakness in the resource sector. Bond markets were firmer as US 10-year treasury yields fell 10bp to finish at 2.86% while in Australia 10-year government bond yields fell 23bp to 2.49%. The AUD continued its year long decline falling another 3% against the USD based on the widening interest rate differential and trade concerns with our largest trading partner China. Bulk commodity and base metals prices were generally weaker however oil rose 3%.

US corporate profits continue to be the bright spot

As foreshadowed last month, the US profit reporting season for the second quarter wrapped up during the month with earnings up 25%, vindicating the valuation investors are still prepared to pay for US shares. Even stripping out the impact of the tax cuts, results showed solid revenue growth of 9.5%, the strongest result since 2011. With the US economy powering ahead, the reinvestment of corporate earnings will provide on-going impetus for continued profit growth in the period ahead.

The confluence of a strong USD, rising US interest rates and faltering commodity prices have proved to be a deadly combination for emerging markets. Turkey, Argentina, South Africa and Venezuela all suffered heavy equity market and currency declines during the month. The common thread in these economies is a reliance on foreign capital to finance large current account deficits, large budget deficits from poor fiscal discipline, political unrest and a heavy reliance on commodity prices to support national income. Turbulence in emerging markets is certainly not new and unlikely to result in a contagion effect into the developed economy, especially given that much of the current problem is a result of the strength of the US economy.

The Australian economy performed surprisingly well in Q2 posting GDP growth of 0.9% for the quarter to bring the annual rate to 3.4%, the strongest since 2012. The surprising aspect of this result was the resilience of consumer spending which rose 3% over the year. The pace of GDP growth is likely to moderate to around 2.5% to 3%, still very respectable by global standards. A slowing housing cycle, sluggish wages growth, a fall in house prices and an historically low savings rate, is likely to see a slowdown in consumer spending going forward. In addition to this, non-mining business investment remains flat and the drought will subtract around 0.5% from growth over the next year. On the positive side of the ledger, growth in net exports, rising corporate profits and public infrastructure spending will all support growth. The RBA is likely to maintain the current official cash rate of 1.5% for some time to come, given the absence of inflationary pressure especially from wages, which are unlikely to push higher until spare capacity in the labour market is absorbed. Mortgage rate increases by some banks gives the RBA even more reason to stay on the sidelines given the high levels of mortgage debt carried by consumers.

Investment Outlook

Following our recent de-risking move, we have held firm in asset allocation policy this month believing our current stance provides an appropriate balance between risk and return. As long as the US economy remains on track, the global outlook should remain sound despite the reverberations around trade disputes. The maintenance of persistently low inflation is the key to the durability of the market cycle and to date, inflation has printed remarkably well. The Fed will quite rightly want to stay ahead of the inflation curve and will almost certainly hike rates by 0.25% in both September and December this year in moves that are widely anticipated by markets. Profit growth remains the key to the direction for equity markets, and to this end investors have reason to be optimistic about the immediate 12 months ahead.