Market Updates

More stability sees global share markets rise

In February, growth assets built on their January gains. This was due to European policymakers reaching a firm agreement on a strategy to address Greece’s sovereign debt problems. Results from the US quarterly profit reporting season also added to the confidence with company reports indicating that corporate profitability remained strong. The MSCI World Index ex Australia (hedged $A) rose 5.1%.

Top US companies included in the S&P 500, outperformed earnings expectations on the whole delivering profit increases of 5.1% in the 2011 December quarter. This helped the US share market rise 4.1% in February.

Positive sentiment towards the US share market is largely due to the ability of US companies to outperform earnings expectations in a challenging environment. For example, the US manufacturing sector, which accounts for approximately 12% of the overall US economy, has delivered steady growth for over two years. This sector includes companies linked to investment in heavy equipment and auto manufacturers..

The US Institute for Supply Management’s factory index (ISM) aims to measure the health of the manufacturing sector. In February, the index indicated that the sector continued to expand, registering a reading of 54.9. A number above 50 signals growth. This number is encouraging and suggests continued expansion in US manufacturing. However, some risks to the sector remain. These include rising fuel costs and pressures relating to a weak European demand. Nonetheless, the results highlight that US businesses have quickly adapted their business models to the more challenging global environment where competition is more intense.

Ford Motor Company is one example of a US company that has delivered positive earnings in a challenging environment. Ford reported a profit of $US8.8 billion in 2011. This was an increase of $US463 million from a year ago.

Strong corporate fundamentals have also helped corporate credit. As companies such as Ford improve their balance sheets, the perceived risks surrounding corporate credit decreases. This benefits sentiment towards credit markets. In February, the Barclays Capital Global Corporate Index was up 1.4%.

Australian Shares

The S&P/ASX 300 Accumulation Index rose 2.0% in February. While domestic economic data was mixed, the Australian share market benefited from positive company earnings and improved investor sentiment surrounding the near term outlook for the global environment.

The $A rose to end the month at $1.08 against the US. The high $A and weak domestic demand has not been supportive for many Australian companies. This has resulted in many downward revisions for earnings estimates.

In the month, Australian companies reported half year to December 2011 earnings results. Many companies demonstrated they can source profit growth in a difficult earning environment, with 68% reporting a profit increase. Companies such as James Hardie, Brambles, Amcor and Ramsay Health Care delivered a healthy lift in earnings. However, the effects of a cautious consumer and pressures from the strong $A were evident. Even with previous downward revisions to the earnings expectations of companies, a below average number of companies beat the expectations analysts. In the period, 31% of companies beat expectations, which is below the long term average of 45%.

While it is important to recognise many Australian companies deliverd positive statements, fewer Australian companies have met expectations of analysts. This contributed to the underperformance of the Australian share market (+2.0%), relative to the other share markets, such as the US (+4.1%), where a higher percentage of companies outperformed expectations.

International Shares

The MSCI World ex Australia Index (hedged) rose 5.1% and the MSCI World ex Australia Index (unhedged) was up3.2% in the month. Growth assets continued to climb in February. While challenges remain, investors developed a more positive outlook for global shares..

Large international companies in advanced economies like the US have remained highly profitable. This has translated into positive news for share holders. The S&P 500 has increased more than 24% since its 2011 low in October. To date, 394 companies in the S&P 500 have reported earnings for the quarter ended 31 December. Earnings increased 5.1% on average and exceeded the estimates of analysts by 3.2%.

The chart below shows the price investors pay to participate in shares of global companies relative to the level of corporate earnings. In aggregate, corporate are profitable and share prices remain attractive. Recently, improved sentiment has benefited share prices, bringing valuations closer to their long term average. However, share valuations remain below their long term average.

European share markets outperformed due to efforts to improve stability surrounding the region’s sovereign debt problems. In the month, the German share market rose 6.1%, the French share market rose 4.7% and the UK share market rose 3.3%. European finance ministers approved €529.5 billion in aid, in the form of cheap three year loans, to 800 holders of sovereign debt to help remedy the European debt situation and support periphery nations like Greece. The aid aims to shield the region from sovereign default.

Listed Property

In Australia, the S&P/ASX 300 A-REIT Index was up 2.3% and the UBS Global REIT Investors Index (hedged in $A) rose 1.2% in the month.

The sector benefited from positive investor sentiment. Japan was the top performing region (+12.4%) followed by Singapore (+6.6%).

Debt Markets

In Australia, the UBSA Government Bond Index fell 1.0% in the month. Australian 10 year government bond yields rose 0.25% to 3.92% (prices fell). As Australian government bonds are favoured as a safer asset, this rise in yields reflects improved investor confidence. Positive macroeconomic data from the US and Europe contributed to improve investor sentiment. In addition, the market has moved to unwind some of the previously ‘priced in ‘ cash rate reductions as the Reserve Bank of Australia left rates unchanged in February and March.

In February the Barclays Capital Global Government Index (hedged in $A) rose 0.4%. European policy makers and the European Central Bank (ECB) have taken greater actions to help banks finance high yielding sovereign debt. This benefited peripheral countries with higher debt burdens. The ECB provided funding to the Banking sector at a rate of 1.0%. This allows banks to finance their high yielding sovereign debt, from issuers such as Italy, and collect the spread between sovereign yields and their new 1.0% borrowing costs. This provides support and incentives to holders of peripheral European debt. These factors have helped to dramatically bring down yields in countries like Italy. Yields on 10 year government bonds in Italy have fallen 2.28% since the November 2011 high to end February 2012 at 4.98%.

Credit spreads narrowed in February. The Barclays Capital Global Corporate Index rose 1.4%.

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Notes: GDP and inflation rate is most recent data available.

Share markets rise in more stable environment

Global share markets began 2012 with the best January in 18 years. Global share markets (hedged in $A) rose 4.5% in the month. The lack of surprising negative news flow saw investors focus on other factors, such as corporate fundamentals. The upturn in share markets was a positive sign that given the strength of corporate, share markets are priced to rise when the environment is more stable.

However, challenges remain. On the one hand, a recession in Europe is highly probable and in the month the credit ratings of nine European countries were downgraded. Yet, the negative news was not a surprise. In fact, the economic news out of Europe has been better than feared. In addition, European Union policy makers continue to show signs of progress towards a resolution of the region’s debt troubles. On balance, the environment was more positive than investors expected.

European share markets performed strongly in the month. The German share market was up 9.5% and the French share market rose 4.4%. The rise in share markets amidst the downgrades highlight that the world does not need to be perfect for shares to benefit as they are priced for a very pessimistic scenario.

Another example of improved sentiment in a challenging environment is the tightening of the spread between German and Italian government bond yields in the month. Even though the credit rating of Italy was downgraded, the spread, or difference between 10 year German and Italian government bond yields tightened. As we mentioned previously, if investors become more confident in the ability of European governments to engineer a viable debt resolution, this spread would tend to stabilise and trend down. This was seen in the month as policy and economic developments improved clarity around the issues, helping spreads tighten.

Australian Shares

The S&P/ASX 300 Accumulation Index rallied 5.1% in January. While domestic economic data was mixed, signs of stabilisation in the global environment saw a positive turn in sentiment. Investors favoured riskier assets.

More cyclical assets, such as commodities and smaller companies benefited most. Materials (+10.3%), Energy (+8.3%) and Industrials (+6.3%) outperformed. Trade levels remained strong, helping these sectors.

The more defensive sectors lagged, reflecting investor bias towards riskier assets. Information Technology (-2.3%) and Healthcare (-1.2%) fell. Consumer Staples also underperformed (0.8%). The sector performance was largely driven by revenue performance from Coles, which grew for the second straight quarter. Coles’ fourth quarter sales rose 6.7% to $9.4 billion.

Retail sales disappointed again. However, Consumer Discretionary rose 4.4% in January. Negative sentiment previously pushed many companies to low valuations. Stabilisation in the environment has given scope for share prices to rise.

International Shares

The MSCI World ex Australia Index (hedged) rose 4.5% and the MSCI World ex Australia Index (unhedged) was up 1.2% in the month. Fears within Europe eased. Positive economic news from China and the United States also helped. Signs of a stabilisation in the wider environment helped investors focus on the underlying strength of the corporate. Share markets in regions viewed as riskier outperformed.

Emerging markets led the pack (+7.4%). European share markets performed better than or on par with the US (+4.4%), with Germany and France up +9.5% and 4.4% respectively. Small caps also benefited (+3.8%)

The chart below shows how investor sentiment, as measured by the Volatility Index (VIX), is linked to the performance of the S&P 500. When the sentiment is more positive, the VIX is relatively stable and the S&P delivers a better performance, given strong corporate fundamentals. A higher degree of volatility sees the S&P 500 fall. Lately the environment has been more stable and the S&P has risen.

In the US, the S&P 500 rose 4.4%. The fourth quarter earnings season in the US began on a positive note, with companies such as Apple beating expectations. In addition, the economic backdrop in the United States, while slow maintained its growth trend. Manufacturing in the US continued to expand. In the US the Institute for Supply Management Manufacturing Index (ISM) rose to 54.1 in January, up from 53.1. A number above 50 indicates growth.

In local currency terms, MSCI China rose 10.7%. The Chinese economy expanded 8.9% in 2011. In addition, the Chinese Purchasing Managers Index (PMI) rose slightly (50.5). This suggests China’s success in stabilising its growth trend and resilience in their manufacturing sector. This eased investor’s fears around the effects of local fiscal and monetary policies and the knock on effects from Europe’s debt issues.

Listed Property

In Australia, the S&P/ASX 300 A-REIT Index was up 5.4% and the UBS Global REIT Investors Index (hedged in $A) rose 6.1% in the month. In January, global share markets rallied US economic data continued to suggest an improving trend and further progress was made toward resolving the European debt issues. In addition, Chinese economic data suggested a steady growth path. Improved sentiment benefited REITs.

Debt Markets

The Barclays Capital Global Government Index (hedged in $A) rose 1.2% in January. Government bond yields were little changed with yields in many countries such as the US (1.79%) and Germany (1.78%) remaining below 2.0%. In the US, the Federal Reserve Bank indicated they would keep official cash rates low until 2014.

Early in the month the rating agency Standards and Poor’s downgraded the credit ratings of nine European countries. S&P said the key drivers of the downgrades were European policy makers’ insufficient efforts to address the issues in the region. Germany remained the only euro-zone country with an AAA rating.

European Union policy makers agreed on a stricter fiscal-discipline treaty end of month. Yields on Italian 10 year government bonds ended the month 6.09%, down from December 2011. Yields on Spanish 10 year government bonds fell to the end of the month 4.97%. While credit rating cuts occurred, a fall in yields in countries with rating cuts such as Italy and Spain suggests issues are being contained. Portugal remains a concern, with 10 year government bond yields near 15.0%.

The Global Credit Fixed Interest rose 2.6%. Higher yielding bonds and corporate credit delivered the highest returns in January as increased clarity in the environment saw investors focus on favoured corporate fundamentals that supported credit.

Australian Fixed Interest returned 0.10% in January. Australian 10 year government bonds fell to 3.71% their lowest levels since 1951. Australia is one of 11 countries to retain an AAA sovereign credit rating. In a volatile environment with lower sovereign yields, this increases demand for Australian bonds and the $A. The $A rallied against major currencies in January, particularly the $US ending the month at $US1.06.

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Notes: GDP and inflation rate is most recent data available.