Equities rebounded over the month as 80% of companies beat expectations so far in this earnings season. The S&P/ASX 200 was the standout performer over the past month, rising nearly 5% as the Australian Dollar weakened against the US Dollar.
The US S&P 500 index rose over 3% on strong earnings growth and is now trading above where it started the year at. The European Stoxx 600 also benefitted from better sentiment and strong earnings, rising over 4% in the past month.
US 10-year bonds remained around the 3% yield mark over the past month. Corporate spreads also remained lower than historical averages as improved earnings continue to bolster corporate balance sheets.
The Australian Dollar fell from just under 78 US cents to around 75 US cents over the past month as the US Dollar rose strongly against other peers.
The Royal Commission has continued to pressure the financials, primarily the big banks and AMP, which has led to weakness in the wealth management sector of the equity markets. This has rebounded slightly in the past week as results from the banks were generally positive relative to consensus expectations. The Federal Budget also threw up some mild positives as it confirmed the improvement from higher commodity prices and global growth, along with continued concessions for small businesses, increased infrastructure spending, and a commitment to lowering taxes for both individuals and corporations in the future. However, the strong domestic employment conditions from last year has weakened over the past few months and inflation figures also came in under expectations, remaining below the Reserve Bank of Australia’s (RBA) target at 1.9%. Furthermore, consumer sentiment and spending has remained weak despite a spike in February, so the RBA remains unlikely to raise rates in the near term.
Meanwhile, the US economy continues to tick along nicely, with industrial activity readings coming in strong alongside better than expected retail sales and personal spending. Meanwhile, US inflation readings were slightly below expectations at 2.1%, boosting investments as traders speculate that this means that the US Federal Reserve will not need to accelerate the pace of rate hikes. This view was also bolstered by slightly weaker than expected employment and wage figures that were strong enough to allay fears of a slowdown and weak enough that it would not affect the course of rate hikes.
It is also currently earnings season in the US, and most companies have reported positive results, with approximately 80% of companies already elevated earnings estimates. Importantly, many are also beating on revenue estimates, indicating that the rise in earnings did not all come from the windfall of tax cuts. Just prior to the earnings season, expectations were for 20% growth, but the strong results have led to the current estimates of 25% growth. As a result, US equities are now largely in-line with historical Price/Earnings multiples.
China’s economy continues to perform well, with GDP coming in at 6.8%. Although Chinese inflation has been weak over the past few months relative to expectations, industrial activity indicators continue to point toward strong growth despite the looming US trade sanctions. This continues to be the key flashpoint in the coming months but most economists believe that the two countries will come to an agreement, although markets are likely to be volatile due to a large degree of posturing between the two countries.
Chinese equities going global
On 1 June 2018, more than 200 locally listed Chinese companies will be going global in terms of their index listing. Last year, MSCI Inc., the company that runs the primary international equity indices such as the MSCI All-Country World Index and the MSCI Emerging Markets Index, approved the application for mainland Chinese listed companies to join their indices. This approval comes after several rejected applications over the prior five years on concerns around market inefficiency caused by government intervention, capital controls and insufficient regulations to safeguard investors. Previously, it was only companies listed in other markets, such as Tencent in Hong Kong or Alibaba in China that were included in the indices.
This is likely the beginning of a marked shift in global equities. China is the second largest economy in the world, but for years, the Chinese stock market has been absent from global equity indices, although a group of China-based companies were included in the Emerging Markets indices due to being listed in Hong Kong or the US. The addition of mainland Chinese equities will be a gradual one, likely to take several years for full inclusion. Despite being the second largest economy in the world, China’s initial weighting in the MSCI Emerging Markets Index will only be 0.7% but this will likely grow to double digits as China continues to reform and liberalise its equity market. This will likely lead to China-based companies becoming close to half of the MSCI Emerging Markets Index and a double-digit proportion of the MSCI All-Country World Index.
For investors, this means that Chinese equities beyond the mega-caps of the likes of Alibaba and Tencent will become more accessible. This offers more opportunities to invest in themes such as the rising middle class and consumer spending in China. This will also likely lead to large inflows of funds into China’s equity market which could boost valuations to a more global level. Historically, China’s mainland equity market has traded around 10x-11x P/E, a large discount compared to the average P/E of the US S&P 500 index of 16.5x, MSCI World Index average P/E of 15x and the S&P/ASX 200 average P/E of 15x.
Many of our preferred global equity funds currently hold an overweight position in Chinese equities which will hopefully benefit in the form of increased demand for those equities. In turn, this could boost valuations and returns, and also increase liquidity and accessibility of equities in the region. Furthermore, this opens up the opportunity set for many funds that could not previously invest in these companies. It is unlikely that there will be a marked impact from the initial inclusion of China’s equity markets to the global index, the effect is expected to be more gradual, as the inclusion of China A-shares ramps up over time. As funds flow towards China, these will come out of other investment markets which means some selling pressure for other investments.
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This month’s perspective highlights that market sentiment on all asset classes is constantly changing. It is important for us to quickly recognise any threats, to preserve your investment capital or to identify early investment opportunities to maximise any return advantages. At Partners Wealth Group we don’t get complacent with the current state of play and constantly monitor investments and your portfolios.
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