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April 2011
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Outlook for Investment Markets
Investors headed for safety over the past month, because of global political instabilities and the Japanese disaster.
Assets seen as safer (particularly government bonds) benefitted, while riskier assets (shares and some currencies,
including the $A) were sold off sharply. Anxieties have receded more recently, and the flight to safety has to a
degree reversed. While the level of uncertainty remains high, the central outlook for strengthening global economic
activity remains in place, although reined back by high oil prices and Japan's setbacks.
Australian Cash & Fixed Interest
Review
There has again been very little change to short-term interest rates, the Reserve Bank of Australia leaving
monetary policy unchanged. Ninety-day bank bills have continued to trade close to 4.90 percent. Ten-year
Commonwealth bond yields, which were 5.60 percent a month ago, have dropped to a little under 5.40 percent,
reflecting increased global demand for government bonds in a very eventful month. Other longer-term rates also
fell, the threeyear swap rate down 0.40 percent to 5.20 percent. The $A has been weak when global markets have
been worried, and stronger when markets are more relaxed. The $A dipped as low as 98 US cents in the
aftermath of the Japanese news, but has risen back to just over parity again in more recent days. The $A was
down -1.70 percent in overall value over the past month, in part because of the impact of the very strong postearthquake Japanese yen.
Outlook
In its latest (March) minutes, the Reserve Bank stated that "Interest rates on loans were slightly above average...
[Bank Board] Members judged that this mildly restrictive stance of policy continued to be appropriate", indicating
that there are no imminent changes to monetary policy on the horizon. Markets are anticipating 90-day bank bills
to be only marginally higher (five percent) at the end of this year, consistent with no action by the Bank for the rest
of the year. Once the current phase of risk aversion has passed, it's likely that local bond yields will follow
overseas yields upwards. For the same reason, the $A may well remain above parity with the $US as 'risk trades'
become more acceptable and world commodity prices move ever higher.
International Fixed Interest
Review
Central banks have kept short-term interest rates very low in the developed economies. In Japan, where interest
rates were already effectively zero, the Bank of Japan has provided additional postearthquake support by buying
vast quantities of financial assets. In the bond markets, political worries from the developments in Tunisia, Egypt,
and Libya had been leading to increased 'safe haven' demand for government bonds in any event, a trend
exacerbated by the uncertainties caused by the Japanese disasters: prices rose, and yields fell. In the key US
Treasury market, for example, the 10-year yield had reached 3.75 percent on 8 February, but by 16 March (at the
height of worries over Japan) it had dropped to 3.16 percent. In recent days, as risk aversion has abated, bond
yields in the US and elsewhere have risen modestly again, the US 10-year yield now just below 3.30 percent.
Outlook
The developed world's central banks cannot leave short-term interest rates where they are currently indefinitely.
The very supportive monetary policy that was appropriate for the global financial crisis and economic conditions
from 2008 – 10 is not appropriate for the growing world economy of 2011 and 2012. Japan has its reconstruction
issues, and interest rates there could well stay very low for a very extended period. Elsewhere, though, short-term
interest rates are likely be normalised, albeit very gradually and carefully, given the manifold risks around the
global economy. In the US, for example, it will be the end of 2011 before the Fed funds rate reaches one percent
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(if current futures market pricing plays out in reality). The first of the major central banks to move could well be the
European Central Bank, although it too will move carefully. While headline inflation in the Eurozone is above the
ECB's two percent target (2.40 percent in February), much of that is because of food and energy rather than any
general resurgence in inflation ('core' inflation is only one percent).
Bond yields had been rising before the Arab insurgencies and Japanese disasters, which made sense given the
recovering world economy. 'Safe haven' demand has now taken yields back down to levels that seem very much
at odds with the underlying economic fundamentals. If inflation this year is likely to be around two percent in the
US and the Eurozone (rather higher in the UK), 10-year government bond yields of 3.20 percent in Germany, 3.30
percent in the US, and 3.50 percent in the UK represent a close to zero 'real' return (after inflation and tax). Given
that the major developed economies have been issuing very large volumes of bonds to fund their fiscal deficits,
these rates have to improve. As and when risk aversion reduces on the other side of the Libyan conflict, long-term
interest rates look set to resume their rise.
Australian & International Property
Review
The Australian real estate investment trust sector mirrored the wider sharemarket over the past month, trading
sideways in late February but weakening in March, especially around the news of the Japanese disasters, and
then recovering more recently. The overall effect is that the S&P/ASX200 A-REIT Index was down 3.50 percent for
the period.
The pattern was the same for global listed property, the EPRA/NAREIT Index hedged into $A ending up with a
loss of 3.70 percent for the past month. Most of this was down to a slump in the Japanese market, which ended
down 14.0 percent for the month. Other markets did rather better, the United Kingdom and Europe producing only
marginal losses, and the US a small three percent decline.
Outlook
It's 'steady as she goes' in the Australian real estate trust sector, the REITs continuing to refocus more on
domestic assets, to adopt more conservative and sustainable payout ratios, and to strengthen their balance
sheets. The economic outlook remains favourable: as one example, in a year's time the unemployment rate is
likely to be closer to four than its current five percent, which will boost office occupancy rates. There are also no
issues of looming oversupply. The REITs are clearly a lower-risk option than they were before the global financial
crisis, but investors have not thus far been enthused. It may be that the current dividend yield of about six percent
is not quite competitive enough with fixed interest yields to attract substantial buying interest.
The global listed property market is much more difficult to summarise. Media attention tends to concentrate on the
US housing market, which is indeed still weak. The US National Association of Realtors, for example, has said that
the median selling price of a US house in February (US$156,100) was the lowest since February 2002, and prices
have not bottomed yet. The Wall Street Journal's poll of forecasters is picking house prices to drop by one percent
this year, and to rise only very modestly, by two percent, in 2012. Other categories of US property have however
been producing good returns. According to IPD data, funds holding direct US property in 2010 earned a total
return of 14.20 percent (equal parts income and capital gain). The picture's equally mixed elsewhere. In Europe,
conditions vary from strong (in the United Kingdom and Germany's main cities) through to very weak (the
peripheral Eurozone countries). Asian conditions are healthy, as would be expected in a region growing so rapidly,
and property companies are showing good results. China Overseas Land, the biggest of the Hong Kong listed
properties operating in China, has announced a 66.0 percent increase in profit for 2010. But there are question
marks about China's attempts to lean against speculative increases in prices. Many investors are likely to continue
to favour the perceived safety and certainty of fixed interest yields.
Australian Equities
Review
Like markets overseas, the Australian sharemarket had a volatile month, reflecting the international political issues
in north Africa and the Middle East and the disasters in Japan. The S&P/ASX200 Accumulation Index went
sideways in late February and early March, trading around 4800 – 4850, but then sagged to a low point on 15
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March on the news from Japan, at which point prices had fallen 6.75 percent. Shares have picked up again, but
showed a 4.40 percent loss for the past month.
Outlook
There has been no clearly discernible trend in Australian share prices over the past 18 months: prices are still at
the levels of September 2009. This is somewhat surprising, as the performance of the economy over that period
has been healthy, and the outlook is also positive. There is in particular an extremely strong boost to incomes from
export commodity prices, which were already at very high levels but rose strongly again in January and February,
both the miners and the farmers benefitting significantly. Rural export prices were up 29.60 percent in $A terms
over the past year, thanks to supply constraints in some competitor countries and ongoing demand from the
emerging economies, while non-rural prices were up 32.10 percent. Japan aside, which is obviously heavilydisrupted by the recent disasters, there continues to be strong demand at these high prices from the booming
economies of North Asia. The Australian economy is also benefitting from substantial investment in new mining
projects.
There is some substance to the 'two-speed economy' depiction of a booming export sector and a more subdued
domestic economy. Households are feeling buffeted by rising fuel and food bills as well as by the previous
tightening of monetary policy, and consumer confidence dropped on the latest Westpac-Melbourne Institute survey
measure. Even so, the overall picture is favourable: business confidence has recovered smartly from the impact of
the Queensland floods, and the economy should see growth of three to 3.50 percent this year and a bit faster
again (3.50 to four percent) next year. At some point this should be enough to shake the sharemarket out of its 18month-old trading range.
International Equities
Review
World shares peaked on 18 February, after which a combination of political instability and the disaster in Japan
caused prices to fall sharply. By 16 March, when the impact of the Japanese news was at its height, the MSCI
World Index had fallen by eight percent. Shares have had a slight recovery, but whether or not this will last in the
wake of news of Western armed intervention in Libya was uncertain at the time of writing. The Japanese
sharemarket was worst hit: the Nikkei Index, which had been trading in the low 10,000s immediately before the
quake and tsunami, dropped as low as 8227 in intraday trading on 15 March, before recovering more recently. At
its current level (9207) the Nikkei is still down sharply (-15.0 percent) on a month ago. Investors have been, and
continue to be, rattled by this sequence of dramas. The VIX index of expected volatility of US shares rose sharply
on 15/16 March, and although it too has eased back in recent days, it remains higher (24.4) than a month ago
(16.4), indicating ongoing heightened investor anxieties.
Outlook
Analysts were initially quite concerned about the impact of the Japanese disasters on global economic activity.
The consensus that has emerged, however, is that the damage in Japan will not derail what should still be a
decent year for the world economy. There will, of course, be some adverse effects: economic activity in Japan will
be depressed for some time yet until the demand for reconstruction resources kicks in, and some global supply
chains in which Japanese suppliers provide key materials will remain disrupted. The problems at Japan's nuclear
reactors have also put into question the prospects of firms linked to nuclear energy (including uranium miners). But
the damage in Japan was mostly outside the key industrial regions, and pre-quake Japan had not in any event
been relied on as one of the locomotives of the world economy. Forecasts for GDP growth in 2011 had been quite
modest, of the order of 1.50 to two percent. A stronger-thanexpected recovery in the US and continuing growth in
China and India were more important, and they remain in place. The other issue that has been bothering investors
may have a greater impact. This is the recent surge in the oil price, which had been high in the first place. A barrel
of oil was trading around US$90 in January and the first half of February, before further political unrest in a number
of Arab oil-producing countries (and potential spillover effects on others) sent the price even higher. The oil price
has got as high as US$105, and is still above US$100 (West Texas grade is trading at US$101). The oil futures
market sees little relief ahead, either: the price is expected to remain above US$100 all this year and next. This will
act as a drag on growth in oilconsuming economies. The OECD has just published calculations suggesting that the
impact of the oil price rises that have occurred since Tunisia's unrest would be to cut growth in the OECD
countries in 2012 by 0.50 percent (as well as add 0.75 percent to the inflation rate).
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Overall, recent developments have probably acted to take a bit off the pace of global growth, but are unlikely to
have put the prospect of ongoing global recovery from the global financial crisis in jeopardy. There are however
currently high levels of risk in investment markets, some known (the need to put fiscal and household balances
into better order), some unknowable (the insurgencies in Tunisia, Egypt, Bahrain, and Libya came out of the blue).
Investors in international shares should expect volatility as these risks grow or diminish. But the central scenario
remains one of ongoing improvement in world economic activity.
Performance periods refer to the month and three months to 22 March 2011.
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