Monthly Financial Markets Update – November 2015

Nick Ryder, NAB Private Wealth Investment Strategist, highlights how equity markets recorded their strongest rise in four years in October and continue to offer the best prospective returns of any asset class.

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Welcome to our November monthly market update.

Positioning

Despite the bounce in share prices in October, equities continue to offer the best prospective returns of any asset class, supported by low interest rates and supportive central bank policies in Europe, Japan, China and Australia. The expected increase in US interest rates does not, in our view, prevent further gains in US equity prices.

In Australia, larger companies are supported by attractive dividend yields but the earnings growth outlook for many of these companies is subdued. The more attractive parts of the market are the mid-cap growth opportunities – particular companies exposed to Asian consumers and companies that have international growth opportunities.

We continue to favour Europe, Japan and Asia over the United States, which remains more expensive, on average. In fixed income, we prefer floating rate corporate bonds, given markets are pricing in more RBA rate cuts that are unlikely to eventuate

Summary of policy developments

China eases again– The People’s Bank of China cut interest rates again with the one-year lending rate cut 25 basis points to 4.35% per annum and the bank reserve requirement ratio cuts 50 basis points from 18% to 17.5%. The central bank also removed the cap on deposit rates allowing banks to freely set their own deposit rates.

What’s changed in October?

After dropping by more than 10%, equity markets recorded their strongest rise in four years in October, helped by the comments from the European Central Bank that more monetary stimulus may be needed in coming months.

Summary of October market movements:

• Developed share markets rose 7.9% led by a 12% rise in German stocks, while Australian shares rose only 4.4%

• Emerging market shares were up 5.4% with shares in China gaining 10.8%

• 10-year government bond yields were lower in Germany, but higher in the UK and US as the chances of interest rate rises increased

• US corporate bond credit spreads reversed direction with margins falling from 178 to 165 basis points above US Treasury bond yields

• The US Dollar was stronger against the Euro and Yen but weaker against the Australian Dollar and British Pound

• Commodity prices were up slightly with both oil and gold prices up by around 3% in October

Macro monitor

In the United States, the Federal Reserve chose not to increase interest rates at its October meeting, as expected. However in an unusual move, the Fed firmly stated that interest rates may be increased at the December meeting, depending on economic data. Also released in October, was the initial estimate of GDP growth for the third quarter. Growth came in at 1.5% annualised, down from 3.9% in the second quarter, but growth would have been 2.9% had business inventories not declined to such an extent. In general data suggests the economy continues to grow at a steady pace, despite the pressures from a strong US dollar and weakness in other major economies.

In Europe, the European Central Bank signalled it may reduce interest rates at its December meeting, with concern there are downside risks to its outlook for growth and inflation. However, subsequent to the ECB announcement, the October core inflation reading was revised upwards – from 0.9% to 1.0% year-on-year – which was firmer than expected. At the same time, unemployment unexpectedly fell from 11% to 10.8%, which is the lowest rate since January 2012.

In China, economic data was mixed. GDP grew 6.9% year-on-year in the September quarter, down from 7.0% in the prior quarter. Industrial production and fixed asset investment in September were both weaker than expected, but retail sales were stronger, pointing to strength in China’s services sector. To further stimulate the economy, the People’s Bank of China again cut interest rates and reduced the bank reserve requirement ratio. Meanwhile the Chinese Communist Party finalised the 13th Five-Year Plan that will shape economic and social policy from 2016-2020. The biggest news was that China has finally officially scrapped its one-child policy. Other measures included a focus on innovation, strengthening of social safety nets and price liberalisation across a broad range of sectors.

The Australian economy continues to transition from mining investment, to growth in the non-mining parts of the economy. September quarter inflation was softer than expected and the weighted median measure of core inflation rose just 0.3% in the third quarter, or 2.2% for the year.. At the Cup Day Board meeting, the RBA elected to keep interest rates on hold – but noted that lower inflation provided scope to cut rates further, if needed.