Welcome to our monthly market update.

Positioning

It has been a particularly volatile period in equities over the past year – with aggressive sells offs in August/September and January/February giving way to grinding recoveries. The US market is now close to all-time highs, supported by defensive sectors rather than bullish sentiment in the growth sectors. In Europe, continued stimulus from the authorities and some better growth outcomes are being offset by concerns stemming from the banking sector and heightened political tensions across the continent following the UK Brexit decision. In Australia, banks and resources weighed on our market over the past year, although resources have rebounded strongly over the past six months.

We remain neutral in International Equities but are moving to underweight Australian equities:

International equities with higher earnings growth potential continue to screen more attractively versus domestic equities. While there is a chance that domestic stocks may push a little higher in the short term – based on international flows into yield-sensitive sectors, upgrades to miners based on spot commodity prices and some relief that a banking Royal Commission is now less likely following the election result – we believe that these factors will be short-lived. The world is still oversupplied in resources and commodity prices, particularly iron ore, are expected to moderate.

Banks are struggling to find earnings growth as house prices remain stretched, the construction cycle begins to moderate, and the bad debt cycle continues to weaken, albeit modestly. Furthermore, banks will likely need to raise significant regulatory capital going forward – however, we do expect these capital raisings are more likely in 2017 than 2016. While the domestic economy is transitioning and growth remains solid, wages growth is still very weak and relatively good growth in gross national expenditure is unlikely to offset banking sector headwinds.

Fixed income yields: International bond yields pushed lower over the past quarter and significant swaths of the global fixed income universe are now trading in negative yield territory. We see little value in duration assets and remain underweight in this asset class. The U.S. Federal Reserve (the Fed) has backed away from its interest rate tightening schedule, largely on global concerns. U.S. domestic data has improved recently and while we believe a move higher in the Fed’s Funds Rate is likely to be forthcoming (or at least the market pricing) in the next few months, we are not expecting a big deterioration in long end yields this quarter and are content to be only modestly underweight.

Property: We are underweight in our strategic benchmarks. Property has performed strongly over the past year and looks expensive from a relative value standpoint. With bond yields likely to remain around current levels, we are expecting property prices to remain elevated over the forecast period but remain vulnerable to the downside.

Alternatives assets: With traditional asset classes expensive and uncertainty around economic growth and policy, we expect volatility to remain heightened and believe non-correlated strategies remain attractive. We are adding to an already overweight position in our defensive and growth alternative asset portfolios.

Currency likely to weaken: Iron prices have seen strong gains in the first six months of 2016, supported by a China stimulus and some supply curtailments. With the Fed expected to raise rates late in the second half of the year and the China stimulus to run out of steam, we are expecting our local currency to weaken towards 70 U.S. cents. We recommend being fully unhedged in our international equity portfolios.

What’s changed in June?

It was a difficult month for equities with an initial sell off in early June, following the release of weak jobs growth figures in the United States and another decline later in the month following the UK’s decision to leave the European Union. More particularly across asset classes:

• Equities in developed markets lost 1.3% with Japanese stocks losing nearly 10%,and Australian shares losing 2.5%. By contrast, emerging market shares gained 1.7% with gains in Brazil, China, India and Mexico.

• 10-year government bond yields fell to record lows with yields declining about 27-54 basis points in Australia, Germany, U.S., and U.K.

• U.S. corporate bond credit spreads widened on average eight basis points (bps) to 162 bps above US Treasury yields and high yield bond spreads widened 24 bps to 621 bps over U.S. Treasury bond yields.

• On currency markets, the British Pound hit a 31-year low and the Yen rose 9% against the U.S. Dollar. The Australian Dollar gained two U.S. cents to US$0.745.

• Oil prices fell by around US$0.83 per barrel to US$48.27 for WTI and gold rose 9% on safe-haven buying following the Brexit vote

Macro monitor

In the United States, the initial reading of the May non-farm payrolls report was very disappointing with just 38,000 jobs created, well down on the 200,000 monthly market average over the past few years. However, other activity indicators such as the ISM surveys of activity in the manufacturing and non-manufacturing sectors have been reasonably strong. Given the weak employment figures for May, and the UK Brexit vote, the Fed chose to defer any decision to lift interest rates. Moreover, the Fed’s ‘dot point’ forecasts for interest rates show fewer rate hikes this year and next.

In Europe, the economy continues to perform reasonably well. Core inflation continued to edge up, from 0.8% year-on-year in May to 0.9% in June, and the unemployment rate fell from 10.2% in May to 10.1% in June.  Eurozone manufacturing activity indicators improved in Germany and France; however, it remains to be seen what impact the UK’s exit from the European Union will have on activity and growth in the Eurozone over the next couple of years.  One area that is cause for concern is the Italian banking sector where bad debts have risen to €360 billion due to weak growth rates.

In China, the economy is performing in line with expectations. Manufacturing surveys showed flat to slightly weaker activity levels in June but the index of activity was stronger at non-manufacturing and services firms in June, compared with May. The Chinese housing market continues to perform well and new home prices have risen 6.9% over the past year. The housing sector is helping to support overall construction activity.