Market Watch
Economic Commentary
More people, more jobs and more home loans. That sums up much of what happened in the month of June.
The Australian Bureau of Statistics advised us that in late June the population of Australia hit 21 million. Birth rates and rates of migration are both up. It also released data from the 2006 census which showed that young families have significantly increased their debt levels; that potential home buyers in the 20-34 age bracket are staying in the family home and that in the past 5 years median mortgage payments almost doubled to $1,400 per month.
The latest figures on home lending showed the value of lending was up 12.7% on a year ago but the number of loans was up by 8.6%. Average loans sizes continue to get bigger.
Thankfully a further 39,000 jobs were created in May and the unemployment rate fell to 4.2%, its lowest level in almost 33 years.
The Australian dollar (AUD) rose 2.8% against the US dollar (USD) during June. It started the month at US 82.66 cents and ended it at US 85.01 cents. A year ago the AUD stood at US 74.22 cents. The AUD bought 0.4236 UK pounds at the end of June 2007 and 1.10 NZ dollars.
Australian shares
It was a wild month on the Australian sharemarket. New records were set but the volatility resembled a showground thrill ride. The S&P/ASX 300 Accumulation index fell 0.1% in June to be up 29.2% in 2006-07. The All Ordinaries share price index set a new record of 6,421 points but finished the month at 6,310.
Share prices were volatile during June. The market was up or down by close to 1% on eight days during the month. In most cases it was the US market which set the tone. Interestingly the Australian market saw smaller movements than the US. This makes sense given that our market has a greater sensitivity to resources and does not have the home lending problems seen in the US.
Upsetting both the US and the Australian sharemarket were rising bond yields. Higher bond yields in the US had the potential to make their lower quality or ‘sub-prime’ home lending situation worse. It would also reduce the attractiveness of private equity takeover schemes and it was hurting a number of US hedge funds who had borrowed money to invest in the sub-prime lending market. While these problems are of less relevance to Australia, the dips in the Dow and the S&P500 unsettled some Australian investors.
Higher bond yields in Australia reduced the attractiveness of shares, especially those that are purchased for their yield. Such companies often include property trusts and banks. Among companies whose share prices struggled in June were Stockland (-5.2%), Centro Properties (-8.4%), St George (-3.0%) and Westpac (-1.5%).
Despite the headwind of higher bond yields, many companies posted strong rises during June. With oil prices rising from US$64 per barrel to US$70 per barrel, the likes of Oil Search (+6.3%), Woodside Petroleum (+6.4%) and BHP Billiton (+11.1%) all performed strongly.
Corporate activity assisted Wesfarmers (+20.5%) and Toll Holdings (+9.9%). Wesfarmers is involved in a takeover bid for Coles Group while Toll Holdings spun off its port and rail infrastructure assets into a new top 100 company called Asciano leaving Toll as a dedicated transport and logistics company.
The strongest sectors during June were once again energy (+5.0%) and materials (+4.7%). Oil prices were up and growth in China continues to created demand for a broad range of resources. Despite a softer month for commodity prices, the earnings outlook for materials companies (which includes resource companies) remains positive.
Over the course of 2006-07 the smaller companies sector returned 44.4% with small resources up 63.9%. Returns from Australia’s top 100 companies were 27.4% with the industrials sector (+40.6%) performing well. Within that sector Leighton Holdings rose 142.7% while Qantas was up 98.4%. The weakest sector in 2006-07 was energy and it rose 21.1%.
After a very strong year there is cause to reflect. Earnings have risen and the global economy is strong. But asset prices have risen and debt continues to rise. Recent events in China and the US should alert everyone to the fact that risk is not dead. While the medium term outlook is positive we need to be prepared for intermittent short term setbacks. Caveat emptor!
Global shares
From an Australian perspective, global shares struggled in June against the backdrop of a rising Australian dollar and rising bond yields. While the MSCI World index was down 0.9% in USD, it fell 3.6% when measured in AUD terms.
Over the course of 2006-07, the MSCI World index is up 6.0% in AUD terms. This compares with negative 1.4% in 2004-05 and 17.9% in 2005-06.
US markets hit new records again during June but could not maintain the momentum. The Dow reached 13,676 before falling back to 13,408 at the end of June for a monthly decline of 1.6%. The S&P 500 was down 1.8% while the NASDAQ fell 0.1%.
Hurting the US market was fallout from poor lending decisions made in 2005 and 2006. Low quality or sub-prime lending is seeing an increase in default rates. This is expected to dent the profitability of some US financial institutions including a number of hedge funds.
Investors in the US well remember the havoc created in 1998 by the troubles of the hedge fund, Long Term Capital Management and the impact of the Russian loan crisis. Little wonder markets are getting a touch nervous.
For 2006-07 the Dow was up 20.3%, the S&P500 rose 18.4% while the technology laden NASDAQ index was up 19.9%.
Other major markets were mixed in June. The UK market fell 0.2%, Germany rose 1.6% and Japan’s Nikkei index was up 1.5%.
In the UK, the departure of Tony Blair as Prime Minister had little impact on the sharemarket while mainland Europe had to struggle against both rising bond yields and a decision by the European Central Bank to lift the eurozone’s cash rate from 3.75% to 4.00%. The increase in Europe’s cash rate is indicative of stronger economic growth in that region and the subsequent upward pressure on inflation.
New figures in Japan revealed strong spending on business equipment. Job growth is positive in Japan and corporate profits have picked up.
Several emerging markets bucked the trend this month and posted gains. Russia was up 11.1% as oil prices rose while Hungary (+8.3%) is befitting from European growth. China, which finished the month down 15.5%, fell 13.7% in the first two days of the month following tax changes in late May.
The MSCI Emerging Markets index, measured in AUD, rose 1.54% in the month to be up 23.8% over 2006-07.
Higher bond yields and rising cash rates, in parts of the world, are expected to slowly stem the tide of money that has fuelled sharemarket booms around the world. The world economy is in reasonable shape but parts of its financial system are frayed around the edges. The frayed ends need not unravel but they do need to be watched closely.
Fixed interest
During the month of June both bond yields and ninety day bank bill yields moved up with domestic and global issues at play.
Ten year government bond yields began the month at 6.02% and ended it at 6.26% as inflation concerns in the US affected most markets. With the US, Australian and global economies still growing, it remains possible that the US Federal Reserve and the Reserve Bank of Australia (RBA) will have to raise their cash rates.
The RBA acknowledges that inflation is more likely to rise during 2008 than to recede while the US Federal Reserve noted that its predominant policy concern remains the risk that inflation will fail to moderate as expected.
Ninety day bank bills rose from 6.36% at the end of May to 6.44% at the end of June. The UBSA Bank Bill index returned 0.50% in June and 6.37% over 2006-07. The UBSA Composite Bond index returned negative 0.47% in June for a return of 3.93% over the financial year.
Listed property
The Listed Property sector fell 5.0% in June as bond yields moved up and the broader equity market weakened. However, in 2006-07 the S&P/ASX 200 Listed Property Accumulation index still posted a gain of 25.9%.
Of note in the sector this month were a $3 billion capital raising by Westfield Group and a $4.2 billion takeover bid for Multiplex by US property group Brookfield Asset Management. Westfield Group is expected to use its new funds to reduce debt and engage in new developments while the board of Multiplex has given its support to the bid by Brookfield.
At the end of June, the yield on listed property sector was 5.70% compared with a 10 year government bond yield of 6.26%.
Global property markets were also weak in June. The S&P/Citigroup World Property index fell 7.42% but was up 21.7% over 12 months.
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