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With no meeting in January, the Reserve Bank of Australia (RBA) left the cash rate on hold at 1.50% in February. Global conditions continued to improve towards the end of the year as higher commodity prices boosted Australia’s national income. However, labour markets remain mixed and wage growth has been slower than expected, meaning domestic inflation remains below trend.
The RBA’s March announcement remained consistent with a Central Bank on hold. The RBA stepped up its commentary surrounding both the housing market and household balance sheets. Growth in household income remains low, whilst household debt continues to increase on the back of historically low interest rates.
The RBA also expressed some concern about lending standards in some parts of the residential property market, whilst acknowledging that supervisory measures have contributed to some recent strengthening in this area.
Government bond yields trended higher in January and have since stabilised after a rapid jump at the end of last year. Yields increased in response to the potential for higher inflation, a stance which has been supported by recent data releases in Europe and the United States (US).
In January, the US 10-year Treasury yield finished at 2.45%, after reaching a high of 2.51%. Global bonds, measured by the Barclays Global Aggregate TR Index, returned 0.81% in January. Returns on Australian Government Bonds were 0.57%, with the yield falling slightly from 2.77% to 2.71%, some 85 basis points higher than the historic lows in August 2016.
Government Bond yields stabilised during February. The US 10-year Treasury yield finished at 2.39% after reaching a high of 2.49%, while the yield on Australian 10-year Government Bond increased slightly from 2.73% to 2.75%. Global bonds returned 0.91% in February, while Australian Bonds returned 0.17%.
The Australian market had a sober start to 2017, following the strong rally into the end of last year. The S&P/ASX 200 Accumulation Index lost -0.79% in January, following December’s gain of 4.38%. Strong gains came from the Health Care sector (+ 4.76%), led by heavyweight CSL, which jumped 11.84% after upgrading its full year earnings. Materials had another positive month, with the sector gaining 4.74%.
Small stocks lost ground in January with the S&P/ASX Small Ordinaries Accumulation Index declining -2.44%. A strong theme during 2016 was the rotation away from large stocks into small stocks, as investors speculated that large companies would struggle to achieve strong earnings growth.
However, a string of profit warnings from small cap “market darlings” such as Bellamys, caused investors to reassess the risk in the sector. Investors responded by selling down the sector towards the end of the year and allocating funds back to larger “blue chips.”
The S&P/ASX 200 Accumulation Index gained 2.25% in February following January’s loss. Strong gains occurred again in the Health Care sector (+3.84%) led by CSL Limited (+4.95%), whilst Consumer Staples (+4.86%) was the best performing sector for the month. Materials declined by -3.66% largely due to a reduction in commodity prices, in particular copper, from mid – February onwards.
The Australian December half profit reporting season wrapped up in early March, leaving company profits on track for a 19% rise after two consecutive years of falls. The profit turnaround was driven by resources companies, which are on track for a rise in profit of 150%. The jump in profits reflected the benefits of higher commodity prices, with Iron Ore up more than 100% from its lows.
Profit growth across the rest of the market was around 5%. At the end of reporting season, 46% of companies exceeded earnings expectations, while 59% increased dividends. Returning capital to investors rather than increasing capital expenditure was also a theme, with Rio Tinto, Coca Cola and AMP all announcing buybacks.
Australian profit results relative to market expectations
Shares in the United States continued to push higher in January, although a weaker $US meant Australian investors experienced a decline of -2.81% from the US S&P 500. Earnings season was also off to a solid start, with estimates for fourth quarter 2016 earnings showing growth of just under 5% and growth for the full year in the 10–12% range.
While the ‘Trump trade’ was a winner in December, the New Year brought a greater degree of scepticism. Investors were hungry for more detail on President Trump’s policies, especially with regard to tax, regulation and government spending. Sectors such as Information Technology (+4.41%) and Health Care (+2.25%) performed well in January, although the impact of potential regulatory changes on these sectors remains difficult to evaluate. Materials (+4.64%) continued to surge ahead as commodity prices rose. The global MSCI World Net TR Index lost -2.29% in $A terms.
US markets rose again in February, with the S&P 500 gaining 2.66% in $A terms, partially erasing the loss experienced in January. Appreciating commodity prices translated into strong earnings results in the Materials sector. Financials stocks continued to benefit from higher yields.
The scepticism regarding Trump’s polices present throughout January extended into February, as markets awaited further detail. Health Care (+4.75%) continued to perform well throughout February, despite comments from President Trump on pharmaceutical pricing reform. Globally, the MSCI World Net TR Index gained 1.53% in $A terms.
The US reporting seasons concluded in early March with 65% of S&P 500 companies beating earnings estimates, with Info Tech, Health Care and Financials responsible for the largest upside earnings surprises.
Alternatives Strategies – Hedge Funds
The Credit Suisse Hedge Fund Index finished stronger in January and February, with returns of 0.70% and 1.23% respectively. Strategies exposed to rising equity markets were the main driver of performance, whilst strategies which benefit from falling share prices were the main detractors.
Quantitative trend following strategies recouped some of the losses from 2016 during the first two months of the year, with gains in commodities and select equity markets, in particular Japan, driving performance.