Macro
David Bassanese

A resumption of US-China trade tensions saw global equities pull back in May, with the MSCI All-Country World Index declining by 5.7% in local currency terms. As seen in the chart below, this continues the broadly choppy performance of equity markets since early 2018, reflecting the interaction of slowing global growth and trade fears, yet subdued inflation and an increasingly benign interest rate environment. Indeed, bond yields continued to trend lower in May, while the “safe-haven” $US remained firm. Commodity price performance also remained choppy, with May’s risk-off sentiment helping gold prices, but not oil prices.


Asset Class Performance – Aussie equities withstand global sell-off

In unhedged Australian dollar terms, global equities declined by a somewhat smaller 4.2% in May, reflecting strength in global currencies versus the Australian dollar. Contrary to the global sell-off, however, Australian equities produced a feisty 1.7% gain, which was similar to the gains by “safer-haven” asset classes like Australian bonds and gold. Strength in iron-ore prices, a post-Federal election relief rally, heightened expectations of an RBA rate cut and a weaker Australian dollar all contributed to the local equity market’s strength.

Across the seven benchmark asset classes, growth assets are still generally outperforming defensive assets in terms of momentum rank**, with Australian listed property (A-REITs) and Australian equities outperforming global equities. Among defensive assets, declining bond yields are supporting fixed-rate bond returns (especially Australian bonds) over cash and gold.

Global Equity Trends – technology, property and quality

As seen in the table below, across BetaShares currency-hedged global equity sector/thematic funds firmer gold prices contributed to strength in gold mining stocks (MNRS). In terms of relative trends, MNRS, European equities (HEUR) and health care stocks (DRUG) are the strongest performers. European equities have displayed modest outperformance over the past few months.

Across unhedged global equity sector/thematic funds, all recorded declines in May though global quality stocks (QLTY) fell by the least. Reflecting trade tensions, technology exposures, especially with strong Asian links (such as RBTZ and ASIA) suffered relatively heavy falls. In terms of relative momentum, US-focused tech exposures (NDQ ANBD HACK) along with QLTY continue to fare the best.


Australian Equity Trends – resources and property

As seen in the table below, across BetaShares Australian equity sector/thematic funds, financials (QFN) enjoyed relatively strong performance in May – likely reflecting an element of post-election relief that Labor’s proposed changes to negative gearing and franking credit refunds won’t be realised. In terms of relative momentum, resource stocks (QRE) and yield-sensitive property and infrastructure stocks (RINC) remain strong performers. Recent strength in financials has also supported solid relative performance by our fundamentally-weighted Australian equity index (QOZ) over recent months.


Cash, Bond and Hybrid Trends

Across BetaShares Australian cash, fixed-income and hybrid funds, declining bond yields contributed to a solid gain by our long duration corporate bond ETF (CRED) during May, followed by our actively managed hybrids fund (HBRD). Falling yields and tightening credit spreads have tended to favour fixed-rate bonds and hybrids over floating rate bonds (QPON) and cash (AAA) in recent months.


Market Fundamental Outlook

At face value, US equity valuations remain at reasonable levels. May’s sell-off in equities saw the US S&P 500 price-to-forward earnings ratio decline from 17 to 16 – leaving it comfortably within its range over the past few years. With declining bond yields, the US equity-to-bond yield gap is also back to around the average rate over the past few years.

Current earnings expectations imply 12-month growth in US forward earnings of around 10%. Allowing for modest further downgrades, my base case is for 12-month US earnings growth of 5%.

The biggest risk to equity markets is not valuation per se, but escalating trade tensions, which could further slow global growth and earnings. While the US Federal Reserve seems increasingly inclined to cut interest rates if trade tensions escalate further, the net effect of trade woes and lower US interest rates might well still be negative for equity markets.

While the outcome of the US-China trade dispute remains unclear, my base case view is that a trade truce will ultimately be reached before it leads to a serious dent in the global growth outlook – if only because this could threaten US President Trump’s re-election chances next year. That said, even if a more serious trade war is averted, the prospect of only modest earnings growth and an eventual back-up in bond yields suggests only modest equity gains would be likely under even a best-case scenario.

All this suggests a growing level of caution around equities may be warranted this year, with increasing focus on defensive thematics such as quality, and areas of the market such as health care and property/utilities. In Australia, subject to the trade wars, a still generally improving outlook for China should favour the resources sector, while the RBA’s easing bias favours yield-sensitive sectors such as property and infrastructure.

*Asset Benchmarks Cash: UBS Bank Bill Index; Australian Equities: S&P/ASX 200 Index; Australia Bonds:Bloomberg Composite Bond Index; Australian Property: S&P/ASX 200 A-REITs; International Equities: MSCI All-Country World Index, unhedged $A terms; Gold, Spot gold price per tonne in $US.
** 6/12 month momentum rank based on equally-weighted average of 6 & 12 month return performance.
***Outright trend is up if the relevant NAV return index is above its 12-month moving average and the slope of the moving average is positive. Relative trend is based on the ratio of the relevant return index to its broader Australian or global benchmark index.



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