Welcome to our monthly market update.

Positioning

Over the past month or so, markets have continued to be largely range bound. Central bank rhetoric has shifted slightly from continuing to do ‘whatever it takes to support growth and inflation’ towards a more balanced assessment and the need for other forms of policy to assist in lifting investment and growth rates; namely infrastructure spending. Economic numbers have continued to point to a world that is growing – albeit at a moderating pace. The concerns from earlier in the year around Brexit, bad debts in the European and Chinese banking system and terrorism have moderated somewhat – although remain bubbling away in the background. Several important elections are dominating investor sentiment while corporate earnings have generally been on expectations and broadly supportive of valuations. Overall, we remain a little cautious and are holding an overweight position in cash and an underweight position in equities.

Equities: We continue to favour International Equities over Australian equities: While the Australian economy continues to post solid growth numbers on the back of exports and a strong housing and infrastructure cycle, corporate earnings, in general, continue to be somewhat muted. Top line earnings growth remains tough and cost out and efficiency programs are largely responsible for many companies meeting their lower guidance numbers. Miners have enjoyed earnings upgrades on the basis of higher spot commodity prices, but further gains are expected to be limited.   We remain underweight Australian equities as we expect commodity prices to moderate and investors to position for the end of the housing construction boom. Concerns with the over- build of apartments and price weaknesses in several capital cities are already starting to trouble investors. Growth in corporate earnings in offshore markets remains a little more positive and we therefore remain neutral in international shares.

Fixed income: The change in central bank communications has seen investors reassess the view on long term interest rates. As further rounds of quantitative easing have become less likely, we have begun to see a modest uplift in long term interest rates. We still expect the US Federal Reserve will raise the Federal Reserve funds rate once this calendar year while further moves in the Australian cash rate are considered unlikely. We remain underweight fixed income as we expect rates to continue to lift gradually. A more pronounced market selloff in bonds is not expected.

Property: We remain underweight property. With bond yields rising, property has started to underperform and we believe this trend should continue. While we are not anticipating a major shock to global bond yields, property valuations remain elevated and are thus vulnerable to downside shocks over the remainder of this year.

Alternative assets: While bonds, and to a lesser degree equities, have cheapened up, the overall level of these asset classes remain relatively expensive by historical standards. Volatility remains elevated. We continue to expect that strategies targeting returns that are non-correlated with the major asset classes should continue to add value to portfolios and we remain overweight in both defensive and growth alternatives.

Currency: The Australian Dollar strength through 2016 has surprised many commentators. The China stimulus from earlier in the year continues to work through the system and iron ore prices remain elevated despite some uptick in supply. Coal prices have also benefited from mine closures in China. The stronger commodity prices, combined with a less aggressive US Federal Reserve tightening cycle has seen the Australian Dollar hold at around 76 US cents for several months.   We continue to expect that the Australian Dollar will moderate into year-end as the US Fed tightens policy and commodity prices moderate.

 What’s changed in September?

In early September equity markets sold off after comments from a US Federal Reserve official suggested that interest rates could be increased at the September Fed meeting. However, markets recovered later in the month after the Fed’s Open Market Committee elected to keep interest rates unchanged.

Developed share markets returned 0.2% in September in local currency terms. The Australian market rose slightly more with a return of 0.5% for the month. Energy shares were the best performing global sector, helped by an 8% rise in oil prices in September.

International bonds were mixed with higher government bond yields in the United States, UK and Australia and lower yields in Japan and Germany.

US corporate bond credit spreads widened marginally by four basis points to 143 basis points above US Treasury bond yields.

The Australian Dollar rose 1.4 US cents to US$0.7653 and the Yen and Euro were also a little stronger against the US Dollar.

Oil prices rose 8% to US$48.11 per barrel for WTI and gold rose 1.0% in US Dollar terms.

Macro monitor

In the United States, the economy has continued to perform reasonably well. September’s non-farm payrolls report showed 156,000 jobs were created, which was a little weaker than expected, but strong enough for policymakers to lift interest rates again, most likely in December – assuming that the next couple of employment reports show no material weakness. Also last month’s sharp falls in the ISM manufacturing and services indices proved to be one-offs. In September, the ISM manufacturing index climbed back above 50 and the services ISM rose to 57.1, which is the highest level since October last year.

In Europe, Germany saw a very large rise in the IFO business climate index as concerns over the UK’s Brexit decision receded. The Business Climate Index rose 3.2 points to a seasonally-adjusted 109.5 in September, the highest level since July 2014.  And in the UK, the unemployment rate was unchanged at 4.9% in July, which was as expected, indicating there was some post-Brexit resilience in the labour market.

n China, the economy continues to be supported by strong new home price growth and robust housing construction in the major cities. And the most recent set of Chinese economic indicators were stronger than expected. Growth in industrial production was up 6.3% year-on-year in August compared with 6.0% in July. Urban investment was steady at 8.1% year-on-year and retail sales rose 10.6% year-on-year, which was up from the 10.2% growth rate in July.

In Australia, the economy continues to grow at slightly above long-term trend rates, helped by the housing and services sectors. Although employment fell by 3,900 jobs in August, which was weaker than expected, the unemployment rate fell from 5.7% to 5.6%, which is the lowest rate in three years. Retail sales were stronger than expected in August, growing 0.4% over the month following flat results in June and July. However, despite the rebound in August, annual growth in retail sales has been trending lower indicating consumers are becoming more cautious.