Themes For May

Elections, trade wars and interest rate cut expectations dominated the financial headlines in May which saw global financial markets give back some of the gains recorded so far this calendar year.

The Australian share market was the stand out performer improving 1.1% to be the only developed market to post a positive return for the month. The surprise re-election of the Federal Coalition government confounded opinion polls, thwarting the anticipated introduction of new taxation measures flagged by the opposition Labor Party. In addition to this, interest rate cut expectations and a relaxation of loan affordability measures by APRA gave the local market a long overdue shot in the arm.

Things were not so rosy for offshore markets as the long running trade dispute between the US and China re-emerged as a threat to the global growth outlook. The major protagonists were hard hit with the US market down 6.6% and China 7.2% while the rest of the world fared little better with Europe down 6% and Japan 7.4%.


The “risk- off” environment and flight to security saw bond markets roar ahead as Australian 10-year bond yields fell 33 basis points to a record low of 1.47%, while US 10-year treasuries fell 36 basis points resulting in a 20 basis point inversion of their yield curve, often the harbinger of an on-coming recession.

In anticipation of lower global demand, the oil price fell 16.2% while iron rose 5.9% as supply disruptions from Brazil’s Vale mine provided strong support for the steel making commodity which is now up a staggering 49.7% over the past 12 months.

Rate cut expectations pushed the AUD down 1.6% against the USD which itself was slightly firmer against other major currencies.

Fundamentals Improve for Australian Shares

For quite some time we have held a cautious view about Australian shares preferring the fundamentals available in global markets. By international comparisons our market is highly concentrated with large weightings in sectors such as Materials and Financials and lower weights to high growth sectors such as Information Technology and Health Care. Despite the run-off of the mining boom, the Australian economy has avoided recession but muddled along without the same level of monetary and fiscal stimulus enjoyed by many countries overseas.

Inflation has remained persistently below the RBA’s target range largely due to a tepid employment market and modest wages growth. These factors in addition to the negative wealth impact of falling property prices has constrained the level of private consumption which accounts for around two-thirds of GDP. It is important to remember that the RBA did not cut cash rates to the same emergency levels as their foreign counterparts and did not introduce quantitative easing (QE) measures to boost money supply to further stimulate the economy. The Federal government also placed a much higher priority on restoring the budget to surplus meaning that tax cuts and large government spending programs were not implemented.


In the lead up to the Federal election the local market had anticipated a likely win by the opposition Labor Party whose progressive agenda was to be financed by measures such as removing the refund of excess franking credits, halving the 12-month CGT discount and curtailing negative gearing for property investments. The franking credit refund change would have reduced demand for the shares of high fully franked dividend paying companies such as the banks. While the market’s post-election relief rally was curtailed by the re-ignited trade war, the fundamentals supporting the Australian market have undoubtedly improved.

The newly re-elected Morrison government have a strong mandate to implement their proposed tax cuts and as expected the RBA cut interest rates by 25 basis points in early June and are now likely to follow through with two or three more cuts in the next 12 months. There is now renewed optimism in the economy most evident in the property market which has seen auction clearance rates sharply higher on expectations that the bottom of the property cycle has been reached. The confluence of improved confidence, tax cuts, interest rate cuts and improved lending conditions should be a fillip for the local economy and the profits of the companies exposed to it. 

Investment Outlook

The major risk overhanging the outlook for shares remains the trade dispute between the US and China. It is impossible to be definitive about the likely path of this dispute as the core issues of forced technology transfer, IP theft and cyber security remain problematic. While this may be a constraining factor for share markets, the likelihood of the continuation of easy liquidity conditions will support equity valuations. Recent comments by FOMC member Bullard and Fed Chairman Powell indicate a willingness to cut rates, if necessary, to support US growth, while in Europe very easy policy conditions continue and of course the RBA has cut rates here.

While bond markets have rallied strongly in anticipation of these events, the risk mitigation qualities they provide in a multi-asset portfolio are still of value for downside protection. In response to the improvement in the outlook for the Australian market, we decided to marginally increase the weighting to this asset class by taking profits in USD cash. While we still prefer the fundamentals for global equities, this change in strategy is a recognition that the differential has narrowed as a consequence of recent events.