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Key Market Trends – bonds still driving equities
There were more modest moves in global financial markets over July, with earlier aggressive expectations of US Federal Reserve interest rate cuts tempered somewhat by signalling from the Fed. US-China trade tensions also continued to linger while markets braced for the Q2 US earnings reporting season.
US 10-year bond yields were steady and the $US lifted by 2.5%. The S&P 500 rose a more modest 1.3% after a strong 6.9% gain in June. Global stocks rose 0.8%.
In Australia, the RBA cut rates for the second successive month and signalled it was prepared to do more to boost growth and inflation. Local bond yields and the $A dropped notably, while the S&P/ASX 200 – also helped by stronger iron-ore prices – posted a solid 2.9% gain.
In terms of major trends, equities, gold and iron-ore are still pointing up while bond yields, the $A and oil are still pointing down. The $US’s gain in July saw its trend indicator turn positive.
Asset Class Performance – gold shines as $US weakens
Supported by stronger iron-ore prices and falling local interest rates, Australian equities were the best performing of our seven major asset classes in July, returning 2.9%. Falling bond yields allowed A-REITs to produce another good return of 2.6%, followed by unhedged global equities (2.2%). Bonds produced positive, but more modest, returns – along with gold.
Across the seven benchmark asset classes we track, 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, gold retains the strongest relative performance rank – while cash is no longer ‘king’ and has the worst relative performance rank of all the asset classes.
Global Equity Trends – gold, quality and technology
As seen in the table below, across BetaShares currency-hedged global equity sector/thematic funds higher gold prices contributed to further strong returns for gold mining stocks (MNRS). In terms of relative trends, MNRS, European equities (HEUR) and food producers (FOOD) are the strongest performers, although only MNRS has a positive relative trend.
Across unhedged global equity sector/thematic funds, technology and quality exposures – NDQ, HACK and QLTY – performed solidly in July. These are also the top three performers in terms of relative momentum.
Australian Equity Trends – resources and yield
Reflecting stronger economic growth hopes due to RBA rate cuts, smaller cap stocks (SMLL and Ex20) enjoyed relatively strong returns within the Australian equity market in July. High yield (EINC) and property and infrastructure stocks (RINC) also continued to perform well.
As seen in the table below, across BetaShares Australian equity sector/thematic funds, infrastructure (RINC), resources (QRE) and high-income stocks (EINC) are enjoying the strongest relative momentum, with the former two exposures displaying a positive relative trend against the market.
Cash, Bond and Hybrid Trends
Across BetaShares Australian cash, fixed-income and hybrid funds, the steep decline in local bond yields produced a strong 1.8% return for our long duration corporate bond ETF (CRED). CRED has returned 10.6% over the past six months and 14.6% over the past year.
Market Fundamental Outlook
Hopes of aggressive central bank action and a ceasefire in the US-China trade war have supported equity markets in recent months. With relatively flat forward earnings growth, this pushed the S&P 500’s forward PE ratio to a reasonably lofty 17 by end-July. That said, falling interest rates remained supportive of valuations given that the US equity-to-bond yield gap also pushed higher, to be in the upper half of its range of recent years.
Given this relative value, if bond yields stay reasonably low, there’s scope for equity prices and valuations to continue to ‘melt up’. US earnings growth should also continue to grind modestly higher. All up, my base case of modest global growth and low global inflation continues to bode well for equities.
One concern remains a major back-up in bond yields, especially if the US Fed signals a less aggressive stance toward rate cuts if the economy continues to hold up and/or wage inflation starts to stir. That risk appeared to be partly playing out following the Fed’s late-July rate cut – with Fed chair Powell telling markets not to expect a “long series of rate cuts”.
That said, bond yields quickly fell back following the ratcheting up in US-China trade tensions. Indeed, to some extent these two risks are offsetting – as heightened trade tensions would make it more likely that the Fed would cut interest rates further.
A further ratcheting-up in trade tensions would likely see equity markets weaken, even if the Fed lends further support. The concern is that trade tensions may now need to get worse – hurting both stocks and global growth – before both parties feel compelled to compromise and strike a deal.
Although this has been tested in recent days, my base case view remains that a trade truce will ultimately be reached before it leads to a serious global bear market or economic recession – if only because this could threaten US President Trump’s re-election chances next year.
*Trend: 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, and down if the index is below this moving average and the slope of the moving average is negative. No trend is displayed in all other cases. Relative trend is based on the ratio of the relevant return index to its broader Australian or global benchmark index.
**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.