Themes For June

Share markets clawed back most of the losses recorded in May with major exchanges finishing strongly in the black. Fueled by the growing expectation of a Fed rate cut, the US market surged 6.9%, while Europe +4.7% and Japan +3.3% also posted solid returns. Mainland China improved 5.4% on hopes that trade talks with the US during the G20 summit in Osaka may avert an escalation in trade tensions. Following on from its stellar performance in May, the Australian market posted a respectable +3.2% to bring the full financial year return to an impressive +11.5%. A strong iron ore price boosted the major resource names with BHP & FMG both up 6.6% while interest rate sensitive listed real asset stocks such as SYD +8.8%, TCL +7.8% and GMG +10.8% were market stand outs. The local bond market continued its impressive run as expectations of further rate cuts by the RBA pushed the 10 year government bond yield down 15bp to another record low of 1.32% while the whiff of a rate cut propelled US 10 year treasuries yields 26bp lower to 2.01%. While local interest rate cuts would normally see a depreciation of the AUD, it has remained stubbornly high around the US 70c level supported by the burgeoning iron ore price which continues to be driven by supply disruption from Brazil.

Liquidity still the main game in town

 The main lesson we have learned in the 10 years since the GFC is that lower interest rates and easy liquidity conditions are very good for both share and bond prices. During 2018, the US Fed began to withdraw monetary stimulus by raising interest rates and reducing money supply but it appears now they are reversing course and aligning with the ECB, BoJ and our own RBA by potentially easing policy again. While the US economy appears quite healthy, the Fed remains concerned about the adverse economic impact of a drawn out trade war and stands ready to inject stimulus if required. In recent months, the RBA has joined the party by cutting rates twice and signaling there are more to come. It is likely that the local cash rate will fall to 0.5% over the next 6 months which in combination with recently passed tax cuts and improved confidence levels will be a fillip for both the property market and the broader economy. The knock on impact of lower interest rates is that the yield on all financial assets falls as the search for income pushes prices higher. With global inflation still trending down below target levels, easy monetary conditions are likely to continue for some time and will support equity prices even as they approach record highs. It’s worth remembering that when interest rates fall, the earnings yield (E/P) for shares also falls and therefore the inverse of this equation (the P/E) rises as investors are prepared to pay more for any given levels of earnings. While valuation measures such as P/E’s appear stretched compared to history, it must be remembered that bond yields are at all time lows and likely to fall further so it is entirely reasonable for share prices to move higher.



Investment Outlook

Our medium term strategy assessments have not changed materially over the past month and hence we are holding course on asset allocation strategy. The major threat to the outlook remains the potential for slower global growth due to rolling trade disputes between the US and other regions especially China but also Europe, Japan and India. Even the much heralded revision to the trade treaty between the US, Mexico and Canada has yet to be ratified by the US Congress. While earnings growth will continue to be modest, easy liquidity will support equity markets for the foreseeable future and bond yields are likely to reach new lows. In May, we increased the weighting to Australian shares but for now the prudent course is to maintain current levels of diversification which we believe to be appropriate in the current environment.