Volatility returned to markets in August, driving equities lower while safe-haven assets enjoyed solid gains.
The downturn in equity markets was largely driven by increased trade tensions and geopolitical uncertainties.
Over the month, investors favoured large caps, low beta and low volatility stocks. Dovish statements from the European Central Bank (ECB) and People’s Bank of China (PBoC), along with rate cuts in New Zealand, India and other emerging markets somewhat alleviated investors’ concerns. The US Federal Reserve (Fed) is expected to further cut rates given higher downside risks and low inflation expectations. Emerging Markets were the worst performers in global equities over August.
In terms of sectors, Utilities and Real Estate were the best performers, while Energy continued to lag. Despite a volatile month, the VIX levels remained low and below spikes exhibited in February this year.
Geopolitical risks remained elevated over the month as the newly elected UK Prime Minister, Boris Johnson, suspended Parliament to enforce Brexit, Italy avoided new elections by reaching a coalition agreement last minute, Argentina requested the International Monetary Fund (IMF) restructure $191 billion of debt in the face of near default and anti-government protests in Hong Kong intensified.
The US Dollar strengthened against major currencies, particularly the Yuan and the Euro, driven from strong inflows. Emerging market currencies weakened and emerging market equities and bonds suffered the worst outflows since 2016, on the back of the cautious Fed monetary policy outlook and increased macroeconomic risks. The US and China trade dispute deepened in August after the existing 10% tariff imposed by the US was increased to 15% on Chinese imports worth US$300bn. To counter, China raised tariffs from 5% to 10% on US$75bn worth of goods. Many major central banks have signalled additional monetary stimulus and lowered their inflation policy benchmarks.
The US treasury yield curve inverted in August raising concerns of a potential US recession. Bond markets delivered mixed results, as sovereign bond yields continued to fall in line with expectations of more stimulus, whilst high yield bonds rose. During August, emerging market debt suffered as a result of growing valuation concerns. Defensive stocks and interest rate sensitive REITs performed well and US long duration bonds outperformed majority of stocks. The decline in interest rates this year has pushed the market value of negative yielding bonds to almost US$17 trillion.
The Australian equity market fell from July, with the S&P/ASX300 returning -2.3%, underperforming its hedged overseas counterpart by 0.3%. Domestic small caps performed poorly over August, returning -3.9%. Healthcare (+3.4%) and Real Estate (+2.4%) were the best performing sectors, while the weakest performing sectors were Materials (-7.3%) and Energy (-5.6%).
- The Reserve Bank of Australia (RBA) decided to leave the cash rate unchanged in its early September meeting at 1.0% per annum (pa). RBA Governor, Philip Lowe, noted that the outlook for the global economy remains reasonable, however risks are tilted to the downside due to trade disputes and the slowdown in international trade has contributed to slower growth in Asia. Long term government bond yields have declined and are at record lows globally and in Australia.
- Employment growth has been strong over the past year, despite the unemployment rate recently remaining steady at 5.2%. Inflation pressures remain subdued and this is likely to continue for some time. The RBA estimates underlying inflation to be around 2.0% over 2020 and to move slightly above 2.0% over 2021. There are tentative signs that house prices are now stabilising in Sydney and Melbourne, with credit conditions also stabilising. The recent decision to lower the cash rate to 1.0% is aimed at filling the spare capacity within the economy, assisting in reducing unemployment and providing more stable progress towards the inflation target. However, the board will continue to monitor developments, particularly in the Australian labour market, and is ready to ease monetary policy further if needed.
- Australian seasonally adjusted employment increased by 41,100 in July, above expectations for a 14,000 rise while June figures were revised to a decrease of 2,300. The unemployment rate remained at 5.2% for July, in line with expectations. The participation rate increased to 66.1%, above expectations for 66.0%. Part time jobs increased by 6,700 and full-time jobs increased by 34,500.
- Australian building approvals decreased 9.7% month-on-month to be down 28.5% for the year to July, compared to previous levels of -0.8% (revised) and -25.0% (revised) for respective periods ending June.
- The Institute for Supply Management (ISM) Manufacturing Index recorded 49.1 in August, below consensus for 51.3, and below the 51.2 recorded in July. Of the 18 manufacturing industries, Textile Mills, Furniture and Related Products and Food, Beverage and Tobacco Products were the top contributors, while Apparel, Leather & Allied Products, Fabricated Metal Products and Transportation Equipment were the largest detractors over the month. The ISM Non-Manufacturing Index recorded 56.4 in August, above consensus for 54.0 and above the 53.7 for July. Of the 18 nonmanufacturing industries, the top performers in August were Real Estate, Rental and Leasing, Accommodation and Food Services and Public Administration. Wholesale Trade was the only industry to report a decrease over the month.
- US Non-Farm Payrolls increased by 130,000 in August, below the previous 159,000 increase (revised) for July. The unemployment rate remained at 3.7% over August.
- US gross domestic product (GDP) second estimate for Q2 2019 is 2.0% quarter on quarter (QoQ) annualised, in line with expectations.
- The Caixin Manufacturing PMI in China recorded 50.4 in August, above expectations for 49.8. The indicator signalled a renewed improvement in the overall health of the sector.
- An advanced estimate of the European Core Consumer Price Index (CPI) recorded 0.9% over the year to August, below expectations for 1.0%.
- The Eurozone composite PMI increased to 51.9 in August, above expectations for 51.8 and above 51.5 recorded for July.
- The final estimate recorded for Q2 2019 Eurozone seasonally adjusted GDP was 1.2% for year-on-year (YoY) and 0.2% QoQ.
The Australian equity market underperformed its hedged overseas counterpart index over the month, as the S&P/ASX 300 Index decreased 2.3%. The S&P/ASX 50 and S&P/ASX 100 were the strongest relative performers, decreasing 2.1%, while the S&P/ASX Smalls was the weakest, decreasing 3.9% over the month.
The best performing sectors were Healthcare (+3.4%) and Real Estate (+2.4%), while the weakest performing sectors were Materials (-7.3%) and Energy (-5.6%). The largest positive stock contributors to the index return were CSL, Woolworths and Lendlease with absolute returns of 5.0%, 6.0% and 17.6% respectively. In contrast, the most significant detractors from performance were BHP, Rio Tinto and ANZ with absolute returns of -10.6%, -11.1% and -3.7%, respectively.
The broad MSCI World ex Australia (NR) Index decreased 2.0% in hedged terms and increased 0.3% in unhedged terms over the month, as the Australian dollar (AUD) depreciated against most major currencies. The strongest performing sectors were Utilities (+5.6%) and Real Estate (+4.9%), while Energy (-5.2%) and Financials (-3.0%) were the worst performers.
In AUD terms, the Global Small Cap sector was down (-1.2%) and Emerging Markets was down (- 2.7%) over August.
Over August, the NASDAQ decreased 2.6%, the S&P 500 Composite Index decreased by 1.6% and the Dow Jones Industrial Average decreased by 1.3%, all in USD terms. In local currency terms, major European equity markets also experienced negative returns as the FTSE 100 (UK) decreased 4.1%, the CAC 40 (France) decreased by 0.7% and the DAX 30 (Germany) decreased by 2.0%. In Asia, the Japanese TOPIX (-3.4%), Hang Seng (-7.1%), Chinese SSE Composite (-1.6%) and Indian S&P BSE 500 (-0.6%) all decreased over August.
The Real Assets sector was mostly positive for investors over August. The FTSE Global Core Infrastructure index increased 1.7% and the Global Real Estate Investment Trusts (REITs) increased by 2.0% over the month (both in AUD hedged terms). Domestic REITs increased 1.3% over August, while Australian Direct Property (NAV) returned 0.3% on a one-month lagged basis.
Global bond markets were positive over August as yields decreased across most major regions. The Barclays Capital Global Aggregate Bond Index (Hedged) increased 2.2% over the month and the FTSE World Government Bond (ex-Australia) Index (Hedged) also increased 2.9%. Ten-year bond yields decreased in the US (-50 basis points (bps) to 1.51%), Japan (-12bps to -0.28%), the UK (-21bps to 0.40%) and Germany (-26bps to -0.74%). Two-year bond yields also experienced negative movements over the month as US (-35bps to 1.53%), Japanese (-10bps to -0.31%), German (-14bps to -0.92%) and UK (-3bps to 0.40%) bond yields all decreased.
Returns for existing domestic bond holders were positive over August, with 10-year yields (-30bps to 0.89%), five-year yields (-18bps to 0.69%) and two-year yields (-14bps to 0.73%) all decreasing. Of the Bloomberg Ausbond indices, the Treasury Bond Index produced the highest return, increasing 1.9% over the month, while the Bank Bill Index return was the weakest, returning 0.1% over the month.
The AUD Trade Weighted Index fell to 58.9 over August, down 1.0% from the previous month. The AUD depreciated against the US Dollar (-2.2%), Pound Sterling (-2.8%), Euro (-1.6%) and Japanese Yen (-4.5%).
Iron Ore decreased 28.5% over August, finishing the month at $86.5 per metric tonne. The S&P GSCI Commodity Total Return Index decreased 3.5% over the month. Gold prices finished the month at US$1,529.31 per ounce, increasing 7.1% over the period, while the oil price decreased 6.5% to $60.48 per barrel over August.
Source: Mercer LLC