The global economy in aggregate is ticking along, with positive economic growth against a backdrop of low inflation. The growth, though, is quite varied across the globe – the U.S. has been leading and China has been slowing down. Central banks have cut interest rates, including in Australia. Locally, not a lot has changed, with the Australian economy still growing albeit more slowly than usual. What is of concern is that valuations across many asset classes are high and emphasise the growing risk to the downside.
The share market had a strong March quarter, with the S&P/ASX 200 index providing an 8.9% capital gain and a 10.3% total return including the value of the dividend yield. Financials was one of the stronger sectors, up 12.4% and a 4.0% gain for the S&P/ASX 300 mining shares (having weakened recently particularly as iron ore prices fell).
There’s little sign that an improvement in economic conditions is near enough, or strong enough, to warrant increasing exposure to Australian shares.
The expectation is for single-digit growth in profits this year. There is a view that the recent rise in Australian share prices had less to do with an improving domestic profit outlook and rather more to do with investors ongoing hunt for yield.
Short-term interest rates have dropped this year, local bond yields have closely tracked the U.S. bond market, dropping recently with the yield back down to 2.32% at the end of the quarter.
In terms of its headline rate against the US$, the Aussie dollar was down 6.9% during the March quarter (to US76.3¢ from US82.0¢)
There is a strong expectation in the financial futures market that the RBA will cut rates, with the 90-day bank bill yield tipped to dip below 2% by September and stay there over the following year on current pricing.
Growth may be slow but it is still 2% or a bit more, a growth rate above other countries, so there is no pressure on the RBA. Even if the RBA does not cut in the next month or two, the rates offered by the banks may still fall. Banks have been cutting deposit rates faster than the cash rate has been falling. The RBA's data on banks' “specials” shows the average special in Dec '14 was 3.3% and by March had dropped to 2.7%.
Like the wider equity market, A-REITs had a good March quarter, with the sector providing a capital gain of 8.4% and a total return including dividend income of 9.4%.
International property also had a very strong quarter, with a total return of 17.2%. Predictably, the eurozone markets led the way in the wake of the European Central Bank's efforts to lower long-term interest rates, which are a key variable in the valuation of property.
Listed property prices rose 19.6% in the eurozone as a whole and there were especially large rises in Italy (+30.2%) and France (+25.6%), and German property up 17.2%. UK property also performed well with a rise of 10.2%, while the U.S. (+4.7%) and Japan (+3.6%) had smaller rises (all data in the local currency of each market).
The sector has moved into extremely expensive territory after rising by 20.1% a year over the past three years and the global yield on property is now down to 3.2%.
The U.S. 10-year Treasury yield has been volatile, starting the year at 2.17% it dropped in January to a low of 1.67% (on 2 February), rose in March to a high of 2.25% before falling to 1.94% at the end of March. This reflected a series of changes in the bond market's view of likely inflation, which is tracking lower than expected in an American economy that has been doing well.
In Europe, bond yields have dropped to exceptionally low levels, reflecting the impact of the European Central Bank's new quantitative easing (QE) policy of buying government bonds, which raises their price and lowers their yield. The benchmark for the eurozone, the yield on 10-year German government debt, has dropped to 0.18%, taking other eurozone bond yields down with it.
Japan, after a quantitative easing policy of its own, has the 10-year government bond yield at 0.41% and the 30-year yield at 1.34%. The only significant exception to the world of low or falling interest rates in the developed economies, unsurprisingly, has been Greece, where investors remain deeply worried about further defaults on government debt – the two-year yield is 22% and the 10-year yield 11.5%, in effect signalling a very high probability of default.
The upshot of lower eurozone and U.S. yields since the start of this year is that investors have made capital gains. Eurozone government bonds in particular have done well, with a March quarter total return of 4.3% (in euros), as have U.S. Treasuries, with 7-10 year maturities returning 2.5% and maturities of 20 years or more returning 4.2% (both in US$).
Low yields, and in particular the yield offered compared with the risk taken, and the probability that global interest rates will rise over the coming year triggering capital losses on bonds make international fixed interest less attractive.
Global equities have struggled to make headway over the past nine months, with setbacks in September and October of last year.
Currency movements have been important. While the MSCI World is up 4.4% in local currencies for the March quarter, it is up only 1.8% in US$ as a result of the strength of the US$.
By region, the strongest developed market performance has come from the two areas in which QE monetary policy stimulus has been the greatest. Eurozone shares have risen strongly, with the FTSEurofirst300 index up 15.8% for the quarter, (although the A$ rose by 4.8% against the euro during the quarter, reducing the gain to 10.5% in A$ terms.) Both Germany (DAX +22%) and France (CAC +17.8%) delivered sizable gains. And Japan also had a good quarter, with the Nikkei index up 10.1%.
In contrast, the major economies that have not taken new QE initiatives have made smaller gains, with the FTSE100 in the UK up 3.2% and the S&P 500 in the U.S. up only 0.4%.
Emerging markets show the same picture of a quarter that looks good on paper (+4.6% in local currencies, +1.9% in US$). The MSCI Emerging Markets index at the end of March was little different to its levels nine months earlier.
China's share market was strong, with the Shanghai Composite index up 15.9%, although the rise looks distinctly speculative and liquidity driven, not linked to any likely improvement in Chinese corporate profitability. The other two members of the BRIC group of leading emerging markets were quieter, with Brazil's Bovespa index up 2.3% and India's Sensex up 1.7%.
The overall global economic outlook is one of ongoing modest growth supported by expansionary monetary policy. The regional distribution of growth is patchy and the high valuations of growth assets are a concern, as shown in the recent sharp rises in European share prices. The generally expensive equity markets are now also more vulnerable to financial or political shocks. It's possible that Chinese growth could be in the 4.5% to 5% range and that markets are beginning to adjust to that, as we've seen with the recent price falls for bulk commodities.
Performance periods refer to the period ending 1 April 2015.