Global equities experienced a sharp sell-off during May, with Overseas Developed Shares falling 6.0% in hedged terms. The turnaround in market sentiment, from the first four months of the year, was sparked by increased trade tensions between the US and China, as well as President Trump’s announcement of tariffs on Mexico.

Broadly speaking, the month proved tough in terms of asset class returns. A preference for safety was evident in the market, with large cap stocks outperforming small caps and defensives such as Australian Government Bonds and Emerging Market Debt outperforming global equities and global real assets.

In addition to the trade tension between the US and China, other geopolitical risks remain elevated across the globe, as the uncertainty surrounding Brexit continues following the resignation of Prime Minister Theresa May at the end of May. Consequently, the Australian dollar appreciated 0.8% against the Pound Sterling over the month. Upcoming elections in France and Italy also suggest the potential for increased political division across Europe.

Unhedged Emerging Market Shares returned -5.8%, marginally outperforming their Developed Market counterpart for the month of May. Chinese stocks in particular suffered the steepest drops given they became more exposed to trade risks as the MSCI China Index fell 13.1% in May.

The US Federal Reserve (Fed) left rates unchanged at its May meeting, with the dot plot now suggesting that rates will remain on hold for the rest of 2019. Over the month, the flight to safety amongst investors led to a strengthening of the US dollar (USD) and a sharp decline in government bond yields. The USD rose against emerging market currencies such as the Mexican Peso and Chinese Yuan, as well as developed market currencies. Government bond markets delivered solid returns in May, as the risk-off environment saw the credit spreads on both investment grade corporate bonds and high yield bonds rise, whilst Unhedged Emerging Market Debt increased 1.9% over the month. The yields on Australian two-year, five-year and 10-year bonds also all decreased.

The Australian equity market outperformed most major equity markets over the month, with the S&P/ASX 300 Index increasing 1.7%. In sector terms, Communication Services led the Australian equity market, increasing 7.2%, whilst Consumer Staples (-4.2%) and Energy (-3.8%) were the worst performing sectors. Just three weeks following the Federal election win by the Liberal-National Coalition on May 18, the Reserve Bank of Australia (RBA) used its central monetary policy to lower official interest rates by 25bps to 1.25%. The first rate cut in almost three years has come in an attempt from the RBA to stimulate growth in the Australian economy.

Significant Developments

• The RBA decided to lower the cash rate in its early June meeting to 1.25% per annum (pa), reaching a new all-time low and the first movement seen since August 2016 when rates were dropped to 1.50% per annum. Key considerations in making this decision were in the interest of supporting employment growth and providing greater confidence that inflation will remain consistent with the medium-term target. RBA Governor, Philip Lowe, noted that the outlook for the global economy remains reasonable, however downside risks have increased due to trade disputes and growth in international trade remains weak.
• Employment growth has been strong over the past year, despite moving up from 5% to 5.2% over April, and this growth has also led to some pick up in wage growth in the private sector. Recent inflation outcomes were lower than expected, but still anticipated to pick up. The RBA estimates underlying inflation to be at 1.75% this year, 2% in 2020 and to move slightly higher after that. Adjustments in the housing market continues, with credit conditions also stabilising. The decision to lower the cash rate to 1.25% is aimed at filling the spare capacity within the economy, assisting in reducing unemployment and providing more stable progress towards the inflation target.
• Australian seasonally adjusted employment increased by 28,400 in April, above expectations for a 15,000 rise while March figures were revised to an increase of 27,700. The unemployment rate increased to 5.2% for April, above expectations of 5.0%. The participation rate increased to 65.8%, above expectations for 65.7%. Part time jobs increased by 34,700 and full time jobs decreased by 6,300.
• Australian building approvals decreased 4.7% month-on-month to be down 24.2% for the year to April, compared to previous levels of -13.4% and -25.4% (revised) for respective periods ending March.
• The Institute for Supply Management (ISM) Manufacturing Index recorded 52.1 in May, below consensus for 53.0, and below the 52.8 recorded in April. Of the 18 manufacturing industries, Printing & Related Support Activities, Furniture & Related Products and Plastics & Rubber Products were the top contributors, while Apparel, Leather & Allied Products, Primary Metals and Petroleum & Coal Products were the top detractors over the month. The ISM Non-Manufacturing Index recorded 56.9 in May, above consensus for 55.4 and above the 55.5 for April. Of the 18 non-manufacturing industries, the top performers in May were Accommodation & Food Services, Educational Services and Management of Companies & Support Services. The only industry reporting a decrease was Agriculture, Forestry, Fishing & Hunting.
• US Non-Farm Payrolls increased by 75,000 in May, below the previous 224,000 increase (revised) for April. The unemployment rate remained at 3.6% over May.
• US gross domestic product (GDP) revised estimate for Q1 2019 is 3.1% quarter on quarter (QoQ) annualised, above expectations for 3.0%.
• The Caixin Manufacturing purchasing managers’ index (PMI) in China recorded 50.2 in May, above expectations for 50.0. The indicator signalled broadly stable and slightly improving operating conditions in May.
• A revised estimate of the European Core Consumer Price Index (CPI) decreased to 0.8% over the year to May, below expectations for 0.9%.
• The Eurozone composite PMI increased to 51.8 in May, above 51.6 for April, indicating a modest improvement in growth.
• The revised estimate released for Q1 2019 Eurozone seasonally adjusted GDP was 1.2% for year-on-year (YoY) and 0.4% QoQ.

Australian Equities

The Australian equity market outperformed its hedged international counterpart index over the month, as the S&P/ASX 300 Index increased 1.7%. The S&P/ASX 50 was the strongest relative performer, increasing 2.6%, while the S&P/ASX Small Ordinaries was the weakest, decreasing 1.3% over the month.

The best performing sectors were Communication Services (+7.2%) and Healthcare (+3.5%), while the weakest performing sectors were Consumer Staples (-4.2%) and Energy (-3.8%). The largest positive contributors to the index return were CBA, NAB and Telstra, with absolute returns of 5.4%, 5.2% and 8.3% respectively. In contrast, the most significant detractors from performance were Macquarie, QBE and Bluescope with absolute returns of -10.3%, -9.4% and -21.6%, respectively.

Global Equities

The broad MSCI World ex Australia (NR) Index decreased 6.0% in hedged terms and 4.4% in unhedged terms over the month, as the AUD depreciated against most major developed market currencies.

The strongest performing sectors were Real Estate (+1.7%) and Utilities (+0.5%), while IT (-7.0%) and Energy (-6.9%) were the worst performers. In AUD terms, the Global Small Cap sector was down 5.0% and Emerging Markets was down 5.8% over May.

Over May, the NASDAQ decreased 7.9%, the S&P 500 Composite Index decreased by 6.4% and the Dow Jones Industrial Average decreased by 6.3%, all in USD terms. In local currency terms, major European equity markets experienced negative returns as the FTSE 100 (UK) decreased 2.9%, the CAC 40 (France) decreased by 5.3% and the DAX 30 (Germany) also decreased by 5.0%. In Asia, the Japanese TOPIX (-6.5%), the Hang Seng (-8.4%) and the Chinese SSE Composite (-5.8%) all decreased, while the Indian S&P BSE 500 (1.5%) increased over May.

Real Assets

The Real Assets sector was mixed for investors over May. The FTSE Global Core Infrastructure index decreased 0.3% and the Global Real Estate Investment Trusts (REITs) decreased by 0.2% over the month (both in AUD hedged terms). Domestic REITs increased 2.3% over May, while Australian Direct Property (NAV) returned 0.4% on a one month lagged basis.

Fixed Interest

Global bond markets were positive over May as yields decreased across most major regions. The Barclays Capital Global Aggregate Bond Index (Hedged) increased 1.4% over the month and the FTSE World Government Bond (ex-Australia) Index (Hedged) increased 1.7%. Ten-year bond yields decreased in Germany (-21 basis points (bps) to -0.20%), in the US (-36bps to 2.14%), the UK (-29bps to 0.89%) and in Japan (-5bps to -0.10%). Two-year bond yields also experienced negative movements over the month as German bond yields decreased (-8bps to -0.66%), along with the US (-28bps to 2.00%), the UK (-16bps to 0.60%) and Japan (-2bps to -0.17%).

Returns for existing domestic bond holders were positive over May, with 10-year yields (-33bps to 1.46%), five-year yields (-21bps to 1.17%) and two year yields (-22bps to 1.12%) all decreasing. Of the Bloomberg Ausbond indices, the Inflation Index produced the highest return, increasing 3.0% over the month, while the Bank Bill Index return was the lowest at 0.2% over the month.

Currency Markets

The AUD depreciated against the USD over May, finishing with a Trade Weighted Index of 60.0 on 31 May 2019, down 0.8% from the previous month. The AUD appreciated against the Pound Sterling (+0.8%), whilst it depreciated against the Japanese Yen (-4.0%), USD (-1.6%) and Euro (-1.3%).

Commodities

Iron Ore increased 9.3% over May, finishing the month at $105.5 per metric tonne. The S&P GSCI Commodity Total Return Index decreased 6.8% over the month. Gold prices finished the month at US$1,300.11 per ounce, increasing 1.3% over the period, while the oil price decreased 10.9% to $64.93 per barrel over May.

Source: Mercer LLC