16 Sep August Market Commentary
As outlined in previous commentaries, there have been some further slight reductions in the risk free rate which delineates the threshold between Fully Priced and Overpriced. The return available on a five year term deposit from a major Australian Bank now stands at 4.0%, and this has therefore lowered again the relative thresholds across the risky asset classes depicted below. The relativity between these risky assets has not changed significantly.
Much of the attention from investment market participants continues to be focused on the utterances and actions of those running the world’s central banks. Whilst the extent of post crisis recovery in major economies varies greatly, the significance of the role of central banks and monetary policy is hard to understate. It has been suggested in the past that it will be a good indicator of a return to economic and market normality when central bankers are less prominent in the financial news. For now, and for the foreseeable future, that signpost on the road to recovery remains some way off in the distance.
Each year in August an annual gathering of central bankers and other influential individuals is held in Jackson Hole, Wyoming, and previously this forum has been used for major policy announcements from the former Chair of the US Federal Reserve Ben Bernanke. In 2014 however, Bernanke’s successor Janet Yellen was content to provide confirmation that the policy course being pursued by the Fed since last December would be maintained. That means the last steps to unwind the extraordinary policy of asset purchases designed to boost liquidity would be completed in October. With that, the question that everyone is now attempting to answer is what’s next? Specifically, when will US interest rates increase?
As we covered in last month’s commentary, with rates at effectively 0% in the US, investors have had to endure earning essentially nothing on defensive assets. Not surprisingly, they have thus been influenced to hold a range of riskier assets in their portfolio in order to earn some return, and indeed this was an explicit goal of the policy referred to as ‘the wealth effect’. On that objective at least, the policy would seem to be a resounding success with the S&P 500 index having more than tripled since the depths of the crisis, accompanied by big rebounds in investor sentiment and appetite for risk. However, while it is easy to observe a recovery in the stock market, it is not the same thing as a broad based economic recovery, and indeed there is evidence that most Americans are yet to see much sign of recovery. Discerning between the health of an economy and its listed companies is an important ongoing task.
In time, with changes in policy, it seems reasonable to expect that the flow of money that has gone to risky assets like shares will slow, as rates rise and once again ‘normal’ returns are able to be found in defensive assets like cash, term deposits and bonds. Until that happens though, this leaves the US equity market in the odd but not uncommon situation of interpreting ‘bad’ economic news as ‘good’ for markets. The most recent example of this was the weaker than expected August employment report, which was taken as a sign that the day of any eventual rate rise was likely to be pushed further out.
The phrase that both Bernanke and Yellen have used consistently is that any decision to increase interest rates will be ‘data dependent,’ and the particular data central to their considerations relates to the labour market. On that front there is a mixture of results, in some instances key metrics have recovered to pre-crisis levels, in other areas there has been steady progress towards doing so and a small number are still languishing some way from their prior averages. We continue to monitor this dashboard of the jobs market in the United States, however all other things being equal, most consider we won’t see a rate rise from the Federal Reserve until towards the middle of 2015.
Among the speeches delivered in Jackson Hole, the one given by the President of the European Central Bank attracted the most headlines. It also signifies that the Eurozone and the United States are at much different stages of their respective recoveries some six years after the financial crisis. Mario Draghi has the unenviable task of attempting to chart a monetary policy course in the context of an 18 country monetary union, with vastly different motivations and circumstances amongst those nations. The most recent economic data for the Eurozone makes clear why Draghi felt compelled to make such a significant speech, it carries a clear change in rhetoric and a challenge to the political leadership to pursue fiscal policies that will contribute along with monetary policy to stimulating economic activity.
Growth has recently stalled from what was previously only anaemic levels across the region as a whole,and most recently contracted in several countries including Germany and Italy. Unemployment rates are stubbornly high at 11.5%, and again there are much worse results in individual countries. While Germany looks comparatively better at 6.7% unemployment, the periphery economies are still much worse off. Spain in particular is languishing where unemployment is still at 24%, of which Draghi noted a significant share is structural rather than cyclical. Inflation has been steadily drifting lower for several years now and most recently came in at just 0.3% for the region, clearly some way off the ECB’s target of ‘below but close to 2%’ and understandably has led some to speculate about the chance of deflation.
In a July 2012 speech the ECB President delivered a now famous line: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” At the time there were very real questions about whether the Eurozone and its currency would remain intact, and after this speech that capitulation threat was largely discounted. At the same time it was also widely acknowledged that there remained many difficulties for Europe to navigate, principal among those being the lack of fiscal unity amongst member countries. If Draghi is able to effectively provide further stimulus via a program of asset purchases, and also to have coaxed fiscal co-operation from individual governments, then his Jackson Hole speech will deserve the same historical recognition as the one he delivered two years earlier. Only time, and of course the data, will tell.
10 Year Forecast Returns
|Inter Eq – Dev Mkts
|Inter Eq – Emerg Mkts
|5 Year TD
|+ Currency Impact
|+ EPS Growth (’14 – ’24)
|+ Valuation Effect
|Index Return (Pre-tax)
As reporting seasons go, the most recent results from Australian companies were largely in line with expectations and contained few surprises. The four major banks together represent 28% of the ASX200 index, and delivered profit results that went some way to justifying their continued price strength, though expectations have been tempered about the prospect of continued strong appreciation. There was evidence from the major mining companies that the next phase of the mining boom is upon us, where increased volumes are met by lower commodity prices.
Our long term forecasts continue to show quite a disparity between the outlook for Developed Markets and Emerging markets, and on that basis we continue to favour the latter. In our modelling we of course look at those regions in more detail, and it is worth highlighting that there is a wide range of forecasts for individual countries within those broad labels. In Developed Markets we have a much lower expected return for the United States than we do for parts of Europe, though the European forecasts come with the attendant risks outlined earlier. Similarly, we have a well-known preference for Asia and particularly China within Emerging Markets, also based on current valuations and forecast returns.
CASH AND TERM DEPOSITS
There has been no change to the cash rate since July of last year. Long term deposit rates reflect expectations that rates will increase in the coming years.DISCLAIMER: The information in this commentary has been provided for publication by Implemented Portfolios (ABN 36 141 881 147. AFSL Number 345143). The information has not been verified by Implemented Portfolios or Adapt Wealth Management Pty Ltd (ABN 76 821 231 362 Corporate Authorised Representative of Paragem Pty Ltd AFSL 297276) but is believed to have come from reliable sources as noted in the acknowledgements. No Liability is accepted by Implemented Portfolios, or Adapt Wealth Management Pty Ltd, its Directors, officers, employees or contractors for any inaccurate or incorrect information. The information is a broad commentary and there is no intention that a client should act on the information without seeking professional assistance from their own advisers (legal, tax, accounting, financial planning) for suitability in respect of their unique circumstances.
About Reuben Zelwer
Reuben Zelwer established Adapt Wealth Management in 2011 to help time poor clients achieve financial freedom. For over 15 years, Reuben has helped professionals, executives, business owner and those approaching retirement make the most of their circumstances by making good financial decisions. Reuben’s professional practice is complemented by substantial voluntary work, which has included setting up financial literacy and savings programs in the local community.