Donegal Update


MARKET UPDATE - July to September 2018

15 October 2018




The Australian Market finished the first quarter of the 18/19 Financial Year with steady growth with the ASX200 Accumulation Index ending 1.5% higher over the quarter.

Nonetheless, political uncertainty and mixed economic data has created fragility with both business and consumer confidence, particularly influenced by the signs of slowing house prices in Sydney and Melbourne.

Global equities rose 4.3% over the quarter, however there was a large disconnect, with the predominant performer being the US.

Specifically, in the US, the NASDAQ, Dow Jones and S&P 500 all saw gains over 6% while Japan's Nikkei index rose 7.7%. In contrast, European and UK Markets delivered more modest returns compared to global peers, with the UK's FTSE index and German DAX both ending the quarter down more than 3%.

The Aussie Dollar (AUD) ended the quarter slightly down against the US Dollar (USD) falling from US$0.7402 to US$0.7218 continuing the decline which commenced at the beginning of 2018.

Global currencies are following a similar pattern with other major currencies such as the British Pound (GBP) and Euro (EUR) continuing their declines against the USD over the quarter.

The US Fed remains the only major reserve bank in an extended tightening cycle, with the Federal Funds rate target being increased to 2-2.25% during the quarter. US 10 year Government Bond yields responded accordingly, rising to 3.06%.

The RBA continues to hold rates in Australia at 1.5% with the 10 year Australian Government Bond Yield at 2.67%.

GLOBAL OVERVIEW

In advanced economies, activity continues to grow below potential, with only 45% of countries expected to experience growth, down from 56% in 2017. Moreover, global activity is lagging previous expansions, reaching 3.1% thus far in 2018, while being expected to moderate in 2019, edging down to 2.9%.

The renewed US dollar rally and escalating trade tensions have resulted in an uneven tightening of global financial conditions leading to uncertain consequences for global trade and inflation. Ongoing Federal Reserve interest rate hikes, and US-China trade tension have been exacerbating late-cycle pressures.

Despite heightened geopolitical tension, solid economic data, strong corporate results in the US and the continuing effect of recent tax cuts, helped to propel markets allowing the S&P 500, the Dow Jones Industrial Average and technology-heavy Nasdaq Composite to continue to trade at record highs.

Emerging markets continue to face headwinds with the Chinese industrial slow down combined with continuing trade uncertainties and global monetary tightening reducing the rate at which EM's are growing.

Rising trade barriers, a heavy reliance on exporting goods and services as well as ongoing political uncertainty continue to restrict the European economies across the continent.

Notably, the European political front took another hit, with the resignation of Brexit secretary David Davis. This renewed fears of potential economic consequences as the UK continues to prepare to leave the EU in March 2019.

Japan was the stand out and led the non-US developed markets to modest gains.

Equity valuations continue to be well above average in the US but continue to fall in non-US markets with a number of valuation ratios nearing heights not seen since the dot-com boom or in pre-GC times.

Overall, the key theme over the quarter for global market was the continued divergence of growth and expectations, as the US continues to perform strongly, while other developing and developed economies are either slowing or struggling significantly.

The US Fed has further reduced its balance sheet, while the European Central Bank (ECB) ends quantitative easing at year-end. By the end of 2018, growth in major central-bank balance sheets is expected to turn to contraction and due to the unprecedented post crisis period of global monetary easing, asset market volatility is expected to elevate thanks to the reduced liquidity.

It is likely this impact will be acutely felt in emerging market and high yield debt markets; however, a normalisation of central banking conditions may leave valuations exposed in many developed markets where low long-term interest rates have been used to (perhaps incorrectly) justify current multiples and valuations on high growth stocks.

AT HOME

Whilst the quarter commenced brightly, the ongoing shadow of the banking royal commission, tightening credit conditions and progressive falls in housing prices for Sydney and Melbourne meant the market moved only slightly positive over the course of the quarter.

A series of encouraging domestic earnings updates, accompanied by an unexpected GDP growth rate of 0.9% helped to limit the AUD decline, however this continues to track lower towards US$0.70.

Whilst GDP numbers continue to meet targets and the federal budget moves closer to surplus, the lack of wage growth and inflation continue to leave the RBA in a difficult position, electing to leave the official interest rate unchanged through the quarter.

Household consumption remains a key concern for the RBA, given the large debt burden of Australian households and limited wage growth.

Australia's unemployment rate decreased to 5.0% in the month of September, in comparison to 5.4% in June. This was the lowest jobless rate since April 2012, as the economy added 5,600 jobs and the unemployed declined by 37,000. However, within these figures, underemployment remains stubbornly high, reflecting the broader trend of casualisation of the workforce.

The ousting of former Prime Minster Malcolm Turnbull, and the insertion of Scott Morrison, meant consumer and business confidence continued to decline in response to the political uncertainty faced in the economy.

The S&P/ASX200 finished the quarter at 6207 points. The resources sector continued to strengthen but wasn't enough too offset weakness across other sectors.

The banking sector continues to suffer the fallout of the Royal Commission and broader economic issues - overall bank shares have continued their bear market, with CBA's share price down close to 20% since its 2015 peak.

Healthcare continued to perform solidly over the quarter, primarily led by CSL's ongoing growth - up around 4.5% over the quarter.

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