Welcome to the 2018 Winter Edition of the BFG Report
Market outlook for the next financial year
The global economy looks strong for the next year but different risk factors may affect consumer and business confidence. One source of uncertainty are elections, including the outcome of our own upcoming federal election, which could impact investments. Generally, for Australia, it is expected that interest rates will remain steady and wage growth will remain weak, albeit strengthening slightly. Property prices will continue their correction, but without crashing and unemployment will remain low.
The Reserve Bank of Australia (RBA) has forecast that the economy will grow more this year than in 2017. Upside surprises include a surge in commodity prices if China grows faster than expected. This is less likely given China’s efforts to curb excessive investment and construction. However, disruptions to global growth, where our commodities such as steel and coal are key components, could see our economy struggle.
Wage growth is likely to remain weak. The RBA has signalled that wage-growth pressure is building in the labour market with the unemployment rate at a low 5.5 per cent. However, the underemployment rate remains high indicating there are many people who would work more hours if they could. Until that starts to drop more, wage growth is likely to remain weak.
We should expect to see the unemployment rate fall, given the positive outlook for economic growth. However, this must be balanced against the weak level of consumer demand. Consumers are making up for low wage growth by drawing down their savings or taking on additional debt to finance their spending which cannot continue indefinitely.
Unit construction has recently surged in Sydney and Melbourne and, to a lesser extent, in Brisbane. This new supply still needs to be absorbed by the market. In addition, regulatory restrictions on investment lending appear to be biting with weaker growth in Melbourne and price declines in Sydney in recent months.
This is continuing to play out but an outright crash is unlikely for two reasons. The first is the ongoing immigration intake, approximately 200,000 people last year, which supports housing demand. Secondly, policymakers are incentivised to prevent declining prices given how much Australian household wealth and bank lending is concentrated in property.
Outlook for Australian shares
The Australian market is positioned to perform well, but will likely underperform international shares.
Bank stocks account for a large portion of the Australian share market and given the risk of additional regulations this could hamper profits. High household debt also restricts the ability of banks to grow revenue and hence profits. Natural resources (metals, oil and gas) account for almost a third of the Australian market. While commodity prices have risen thanks to rising global economic growth, they are unlikely to boom.
Not only is wage inflation weak but households are heavily geared. Until the RBA sees wage growth helping to erode this debt we are unlikely to see interest rates move higher.
It’s likely that inflation will remain at or below the lower end of the RBA target rate given the likelihood of limited wage growth. This was further confirmed with annual inflation, to March 2018, tracking at 1.9 per cent — below the RBA target of 2-3 per cent.
Investment Market Review – Quarter Ended 31 March 2018
Asset Class – Australian Shares
1 year is 2.9% p.a.
5 year is 7.6% p.a.
10 year is 5.2% p.a.
The S&P/ASX 300 Accumulation Index underperformed most global markets in the March 2018 quarter.
The index was down 3.8% driven by weakness in financial and telecommunications stocks, which outweighed a mixed but overall positive reporting season. Seven of the ten major sectors that make up the ASX saw upgrades on earnings expectations. The best performers were healthcare (up 6.1%), information technology (up 0.7%) and consumer staples (down only 1.3%). The worst performing sectors were telecommunications down 12.8%, utilities (down 8.3%) and energy (down 7.7%).
Asset Class – Listed Property Trusts
1 year is – 0.10% p.a.
5 year is 10.80% p.a.
10 year is 3.30% p.a.
The Australian Real Estate Investment Trust (A-REIT) sector fell 6.2% in the March 2018 quarter,
as the upward trend of bond yields weighed negatively on the asset class. A-REITs are viewed as a proxy for bonds so poor performance in fixed income, in this case because of the prospect of higher interest rates, can result in poor performance for this asset class. Retail A-REITs continue to struggle relative to other types, such as, residential and office A-REITs, given the ongoing concern over the weakness of their tenants.
Asset Class – International Shares
1 year is 13.0% p.a.
5 year is 16.6% p.a.
10 year is 7.7% p.a.
Global markets had a strong quarter in relative terms with the MSCI World Index gaining 0.3% for the quarter.
This can be attributed to improving corporate earnings, economic fundamentals and forward-looking indicators. This strong backdrop continues to provide support for risk assets across the globe. However, it has faded somewhat in recent months with leading indicators of business activity in both the manufacturing and services sectors not accelerating at the pace shown in January. The share market has been led globally by the technology sector in recent years but the privacy scandal embroiling Facebook’s handling of user data weighed on the sector overall, helping to drive equity returns lower than during the previous quarter. In addition, fears of a series of interest rate hikes by the Federal Reserve saw a sudden increase in volatility in early February. The prospect of a trade war between the US and China, as a result of increasingly aggressive rhetoric between the two following the implementation of tariffs on steel and aluminium imports by President Trump, contributed to this volatility. As a result the S&P 500 fell 1.2%, the FTSE 100 declined 8.2%, the German market lost 6.4% and the Japanese market shed 7.1% during the quarter. US technology stocks (up 2.3%) and emerging markets (up 0.9%) were a few notable shelters from this broad decline. The performance of companies such as Microsoft and Google in January offset the damage caused by the Facebook saga and general market weakness.
Asset Class – Fixed Interest
1 year is 2.9 p.a.
5 year is 4.1% p.a.
10 year is 6.1% p.a.
The Australian three-year bond yield was 7 basis points (bps) lower at 2.05% and the ten-year bond yield fell by 3bps to 2.6% during the March 2018 quarter. The US yield curve rose with the three-year bond yield climbing 39bps to 2.28% and the ten-year up 33bps to 2.8%. At the start of the year, yields rose due to investor optimism surrounding accelerating global growth and the tax reforms introduced by President Trump coming into effect. Rate increases by the Federal Reserve helped drive yields higher as did more hawkish forecasts by the Federal Reserve on the future outlook of interest rates. These factors were countered by increased demand for safe-haven assets, particularly in March, as global trade war fears led to some investors fleeing equity markets which caused yields to fall during March in both Australia and the US.
Asset Class – Cash
1 year is 1.7% p.a.
5 year is 2.3% p.a.
10 year is 3.5% p.a.
The Reserve Bank of Australia (RBA) left the cash rate unchanged at a historical low of 1.5% in the March quarter.
The RBA maintained their concern over low wage growth and high levels of household debt. The RBA’s April minutes from the monetary policy meeting also highlighted that while leading indicators should see wage growth rise, the economic growth picture is less rosy. The RBA implicitly downgraded their growth forecast from 3% for 2018 to ‘growth higher than last year’. The calendar year 2017 generated Gross Domestic Product growth of 2.3%.
High Yielding Internet Savings Accounts
Financial Institution and Interest Rate
RaboDirect Bank – Rate 3.05% p.a.
Rams Saver – Rate 3.00% p.a.
Citi Online Saver – Rate 2.85% p.a.
St George – Maxi Saver – Rate 2.85% p.a.
ME Bank Online Saver- Rate 2.85% p.a.
ING Savings Maximiser – Rate 2.80% p.a.
Rates are subject to conditions and change.
Rates are correct as at 28/05/2018.