Sovereign Wealth Partners & InvestSense Pty Ltd
5 February 2020
Markets fell in the last few trading sessions of the month as the coronavirus epidemic put a large dent in the liquidity fuelled rally that started the year and most equity markets gave back their gains from the first couple of weeks of the year. However, a weaker Australian Dollar meant that international equities actually appreciated by +4.3% in Australian Dollar terms. Emerging markets, of which China is the biggest constituent, remained flat.
While the Australian market also ended the month up +4.9% its relative performance was flattered by a rebound from the previous quarter’s underperformance of 6% (driven to a large extent by the banks). Similarly, Australian REITs posted a very strong return of +6.3%, having fallen by almost 10% in December. In fact, it appears that Australian banks, REITs and some individual stocks are becoming increasingly interest rate sensitive as the opposing influences of a weaker local economy and potential interest rate cuts play out in long-term interest rate markets.
In January Australian 3-year bond yields fell for four consecutive weeks and are again nearing record lows amid growing concerns of the impact of coronavirus on the broader economy and expectations that the RBA is likely to cut interest rates again in 2020. The Australian 10-year yield also approached its record low, and the Australian dollar fell to 66.9 US cents, its lowest level in over a decade.
It was therefore really a fall in interest rate expectations, in turn, due to perceived weakness in the economy, that lifted the Australian equity market. By the same token, it was an apparent improvement in global growth prospects (and the effect that had on local rates) that caused local stocks to lag in December. Australia’s recent induction to the topsy-turvy, ‘good news is bad news’ world of low interest rates may be exacerbated by our relatively high dividend yields (due to dividend imputation) and so our whole market has become a bond proxy for overseas investors as well as local retirees.
Otherwise, the US appeared to be at the epicentre of the risk-on sentiment that fuelled the best part of the month. A better than expected earnings season boosted the likes of the Information Technology and Utilities sectors, while Energy and Healthcare lagged.
Global REITs were up a more sedate +1.3% and infrastructure assets continued to rise, up +3.2% in January. Australian and international fixed interest returned +2.3% and +1.8% respectively, and cash returned +0.1%.
While the full-scale implications of the coronavirus are still broadly unknown, markets were quick to discount such concerns after an array of worsening data showed no real signs of the virus slowing down. An extension of the nation’s Lunar New Year holiday means that most of the economy is still effectively sealed off, however, substantial selling is currently expected once local equity markets reopen. At the time of writing the PBoC announced support of 150 billion yuan ($32.4 billion AUD) to support the country’s $45 trillion financial system and the local currency.
Liquidity injections by the Fed and more recently the PBoC seem to have added to the buoyancy we’ve seen in markets during the month and alleviated some of the concerns investors had coming into the year. As we wrote last month this is something we monitor closely and we remain prepared to take some risk off the table if we see a change in the current buoyant conditions. As we wrote in our most recent blog, we think the news/market anxiety surrounding the coronavirus should improve from here, suggesting that already cheap Asian equities appear increasingly attractive. With respect to the bellwether US markets, we think it is more striking that the market is only down 2% or so and it is still trying to tell us something, namely that it is not ready to collapse just yet and that liquidity remains strong. That said we remain underweight US equities given expensive valuations and the likely impact that would have if something unknowable were to come along.