Welcome to our March monthly market update.

Positioning

While the recent turbulence in financial markets was due to largely unfounded fears of a slowdown in China and the United States, the bounce in equity and commodity prices appears to have been driven by a “short-covering” rally rather than outright buying. We expect market volatility to remain for several months.

In Australia, the first half earnings reporting season wasn’t as bad a feared but earnings growth for the larger companies has been lowered further.The best opportunities remaining among small and mid-sized companies.

Internationally, due to the stronger US Dollar, we continue to favour Europe, Japan and Asia.

We remain underweight in fixed income, preferring floating rate corporate bonds with some value in investment grade and high yield credit.

Summary of policy developments

People’s Bank of China cut its Reserve Requirement Ratio from 17.5% to 17% to spur lending growth and consumer spending.

What’s changed in February?

Equity and commodity markets continued to slump in early February until testimony from Janet Yellen confirmed that the Fed was maintaining a watchful outlook:

Summary of February market movements:

• Developed share markets fell 1.5% led by a 9% fall in Japan, while Australian shares fell 1.8%
• Emerging market shares rose 0.1% with shares in Brazil rising 5.9% while India fell 7.5%
• 10-year government bond yields fell another 20-30 basis points
• US corporate bond credit spreads widened 3 basis points to 205 above US Treasury bond yields.
• High yield bond index spreads narrowed 2 points to 775 basis points over Treasury bond yields.
• The US Dollar was stronger against Sterling, with the Yen rising 7% and the Euro staying flat.
• Commodity prices were 2% lower with oil down to $0.92 and gold hitting $123 per troy ounce.

Macro monitor

In the United States, fourth quarter GDP was revised up to an annualised 1.0% thanks mainly to improved net exports. The ISM manufacturing survey also rose 1.3 points to 49.5. The Fed’s preferred measure of inflation, the core PCE deflator, showed annualised inflation is 1.7%, not far off their 2% target. So while the US Federal Reserve has noted the recent weakness in financial markets, it is possible that markets are underestimating the chances of further interest rate rises in 2016.

In Europe, inflation fell from +0.3% to -0.2%. This increases the chances of the European Central Bank introducing additional measures to combat deflation. Unemployment continued to trend slightly lower, down to 10.3% from 10.4%, and Britain took a step closer to exiting the EU after announcing a June referendum on the issue.

In China, the official PMI index fell from 49.4 in January to 49.0. However, new house prices are up 2.5% year-on-year and credit has been growing strongly. This is helped by the People’s Bank of China further cutting the RRR to 17%.

The Australian economy continues to perform reasonably well. GDP grew a strong 0.6% in the fourth quarter and third quarter growth was revised up to 1.1%. This meant the economy expanded by 3% over 2015 which was higher than the RBA’s prediction of 2.5%. Trend employment growth has been good and consumers continue to spend rather than save. The fall in mining has been partially offset by investment in the housing sector.