Investment market review
27 Feb 2017
By Shadforth Financial Group
Australian shares rose 4.9% in the December quarter.
The strongest performing sector was financials, with a gain of 10.8%, followed by utilities with an increase of 7.8%, the energy sector climbed 7.4% and materials increased by 7.2%. The financials sector led the market higher as investors moved into cyclical sectors following a rise in bond yields and commodity prices. Iron ore and West Texas Intermediate crude oil prices appreciated 41% and 11% respectively, helping the materials and energy sectors post strong results. Sectors that performed poorly included health care, declining by 8.8%, telecommunications which fell 4.3% and the consumer discretionary sector which lost 2.9%. One major reason for the poor performance of the health care sector was a large decline of 55.9% in Sirtex Medical Ltd after they announced weaker than expected sales growth.
Listed property trusts
The A-REIT sector declined 0.7% during the December quarter.
The sector once again underperformed the general market as global bond yields continued to move higher. This was partly due to expectations of increased government spending and lower taxes in the United States following the election of President Trump. Property shares generally suffer from increasing rates because of the drag on earnings, but A-REITs often have inflation-linked leases, thereby delivering a degree of protection in terms of the rents they receive. Despite the recent pullback, the sector still appears expensive on an historic, relative and absolute basis.
International shares performed strongly during the December quarter despite another period dominated by political events — the most notable being the US Presidential election.
Financial market investors revised their expectations for government spending and tax policy in the US following the election and this was an important factor driving share valuations, the increase in
government bond yields and the appreciation of the US dollar. The S&P 500 gained 3.3%, the FTSE 100 rose 3.5%, the German DAX 30 was up 9.2% and the Nikkei 225 climbed 16.2%. The MSCI World Index in Australian dollar terms increased by 8.3% in the December quarter.
The European Central Bank left the deposit rate unchanged at negative 0.40% but decided to continue the current level of monthly asset purchases of €80 billion until the end of March 2017, after which there will be a reduction to €60 billion per month until the end of December 2017. The US Federal Reserve increased the federal funds rate by 25 basis points to a target range of 0.50 — 0.75% at its December meeting. The decision was widely anticipated because data had been increasingly supportive of an interest rate increase.
In the US and Australia, long term interest rates rose more than short term rates, causing the yield curve to steepen.
The US 10-year bond yield rose 85 basis points and the Australian 10-year bond yield rose 86 basis points. In the US, government bond yields moved higher as a result of the interest rate increase and because of expectations Donald Trump’s policies will include a significant amount of spending on infrastructure as well as tax cuts, thereby boosting economic growth and inflation. Australian bond yields were not immune and quickly followed the United States lead due to the high correlation between the two countries’ government bond yields.
The RBA left the cash rate unchanged at 1.50% during the December quarter.
This was despite uncertainty regarding the strength of the labour market, concerns that inflation would remain low for some time and the weaker than forecast GDP growth in the September quarter. Rising oil prices and downside pressure on the Australian dollar as a result of the US Federal Reserve’s intention of raising rates two or three times in 2017 will likely cause the RBA to leave rates on hold during 2017.
The long view
This chart displays the highest and lowest 12-month returns of the major asset classes since December 1996.* As you can see, cash provides stability and security, having never generated a negative return over a 12-month period. The trade-off for this stability and lower risk is that cash will be unlikely to match the higher returns generated by other asset classes.