Investment Markets: Volatility rears its ugly head
For the quarter ending March 2015, financial market conditions seemed “not too hot, not too cold, but just right” for equities. Interest rates remain very low, inflation is low and growth is expected to remain moderate. Investors also pondered what could go wrong and identified the key risks as ‘inflation surprise’, ‘deflation grind’ or something relating to geo-political events in Europe (Greece, Ukraine) or the Middle-East.
As it turned out, it was events in Greece that sparked increased volatility with the small European Union (EU) member on the verge of defaulting after many years of negotiations with ‘the Troika’ being the EU, International Monetary Fund (IMF) and European Central Bank (ECB). The leftist leaning Greek government seems fed up with austerity measures and is seeking some sort of debt write-down either by agreement or by default. A default would leave ‘the Troika’ with around €470bn in bad Greek government and bank debt. For Greece, it would probably mean expulsion from the EU and a major devaluation of any new currency and in turn, a major fall in the value of Greek assets and income.
For access to our previous review of the Greek crisis (CLICK HERE)
While Greece is only a small economy, its default and expulsion from the EU could hurt confidence in other European countries, like Portugal and Spain, and indeed confidence in the European Union itself. It is too early to tell how the situation will unfold but it can be expected that the EU and ECB will move quickly to provide stability to the European financial system to mitigate any contagion risks.
Lonsec (our external Research provider) also notes that given the Greek bad debt is mostly held by ‘the Troika’, and not the private sector, there seems little risk of a GFC type event; it is more likely to be a short term bout of volatility and uncertainty.
Turning to the global economy, conditions remain very diverse with the US closer to its first interest rate rise since the GFC, while Asia and Europe continue to ease monetary policy. It seems overall that the ‘deflation grind’ situation of over-capacity, increased competition and falling prices is a more likely situation than the ‘inflation surprise’ situation of growth and inflation surprising on the upside. Even in Australia, it is becoming evident that competition has increased markedly in many sectors including Finance, Retailing and Resources which make up around 60% of the local share market.
As we move into the September quarter, Lonsec has become a little more concerned about the potential for a correction in the US share market which has been quite resilient since January 2015. Lonsec is concerned that the outlook for a US interest rate hike in 2015, combined with increased uncertainty in Europe, could be enough for investors to take profits in the second half of 2015.
While the Australian market has already retreated around 9% since April 2015, it would still be vulnerable to a correction in the US, so we remain cautious on International and Australian equities, in the short term. We note however, that the Australian market would offer quite good value on a price/earnings and yield basis if it retreated further and this would most likely be a great long term buying opportunity.
Volatility has increased in recent months on events in Europe and a possible US interest rate increase. While conditions remain favourable for equities, there is a good chance that the US share market undergoes a correction in the second half of 2015, which will represent a good buying opportunity for prudent investors, after remaining quite resilient for the first half of 2015.
Market Stats (30 June 2015)
Volatility increased in the last quarter of FY15, with the Australian market retreating 7.0% over the quarter which reduced the FY15 return to only 1.3% (before dividends). Banks (-12.6%) and Materials (-5.4%) led the market lower with large caps retreating. Over the year, large caps did a little better than small caps while Industrials and Real Estate outperformed Banks and Materials.
The Australian market (+1.3%) underperformed the US market (+5.2%) over the year. The big gainers were China (+108.8) and Japan (+33.5%). Other global markets also generally outperformed the Australian market, although the UK market did underperform (-3.3%).
After a long period of remaining on hold, the RBA cut the cash rate by 50 basis points over the year and seems to be maintaining an easing bias. The short end of the yield curve has moved lower but the long end has started to rally, which is leading to a steepening yield curve.
The AUD/USD started to find some support with the currency up 1.3% over the quarter but is still down 18.3% over the year. Some commodities also found some support with oil (+23.8%) and iron ore (+7.0%) staging a rally. However, most commodities finished well down over the year.
Source: Lonsec Investment Insight (September quarter 2015) – released July 2015