Quarterly investment report
June quarter 2008
The environment
The first part of the June quarter saw a brief rally in financial markets as investor risk appetite returned following the bail-out of Bear Sterns, a large US investment bank at the end of the March quarter. The bail-out involved the US Federal Reserve organising the finance for JP Morgan, another large US investment bank, to purchase Bear Sterns and honour its commitments to other financial institutions. The second part of the quarter was notable for a sharp reversal of fortune as investor risk aversion returned with a vengeance due to the growing realisation that economic growth in the developed world was continuing to slow amidst a build-up of inflationary pressures and on-going financial institution losses associated with the credit crisis.
The June quarter saw further evidence of a slowdown in economic growth in the major developed economies. In the US, consumer confidence fell to levels not seen since the recession of 1982. This reflected job losses, rising petrol prices and a decline in housing prices, which have now fallen by around 20% since the middle of last year. Economic growth in Europe and the UK is also showing signs of weakness, while in Australia the Reserve Bank’s attempts to cool the economy are proving successful. Reflecting this, consumer confidence has declined to 16-year low levels, business confidence has dropped sharply and the demand for credit by both consumers and business has slowed noticeably.
While global economic growth continues to weaken, inflationary pressures have increased markedly in most countries, due to significantly higher prices for food and energy. Although core inflation remains largely stable, the danger for policy makers is that higher inflationary expectations become entrenched into core inflation via higher wage demands and second round effects such as the transmission of higher transportation costs. The combination of weaker economic growth and higher inflation has provided policy makers with challenges they have not faced for more than 20 years. By the end of the quarter, the European Central Bank raised short-term interest rates despite evidence of a slowdown in economic growth, while the US Federal Reserve is suggesting the next move in US short-term interest rates will be up.
Financial market performance
Against this backdrop, global equity markets generally declined, with global equities, hedged into Australian dollars, falling by 1%. A significant rise in the value of the Australian dollar meant that global equities in unhedged terms fell by 6.5%. Amongst the major markets, the best performances were achieved by Canada and Japan, which both rose by around 8%. Other markets declined, with some of the largest falls recorded by Asian markets. China fell by 21%, India by 15% and Hong Kong by 3%. The US fell by 3%, while the UK declined by 1%, France by 6% and Germany by 2%.
The Australian equity market declined by around the same magnitude as its global counterparts, with the S&P/ASX 300 Index falling by 1.8%. Resource stocks, which rose by 19%, again fared far better than industrial stocks, which declined by 10%. At the same time, large capitalisation stocks again outperformed small capitalisation stocks. The strong performance of Resource stocks mainly reflected a large increase in oil prices, which rose by 38%. Other commodity price rises were far more subdued, with aluminium rising by 4.5%, copper by 3% and gold by 1%. Offsetting this, nickel prices fell by 30%. Sector performance dispersion in the Australian market was again very large in the June quarter. Energy stocks rose by 34%, Materials stocks by 12% and Information Technology stocks by 5%. This contrasted with a 21% decline in Consumer Discretionary stocks, a 16% fall in Property Trust stocks, a 15% drop in Industrial stocks and a 10% reduction in Financial stocks.
In the June quarter, bond markets struggled to come to terms with concerns over both higher inflationary pressures and the reduced ability of Central Banks to respond to slower economic growth by further lowering the level of short-term interest rates. This resulted in global bonds declining by 1.1%. Australian bonds fared somewhat better, managing a small rise of 0.4%. However, both bond market returns were easily eclipsed by the 2.0% return from cash. Reflecting the decline in global bond markets, 10-year government bond yields rose by 0.5% in the US, 0.7% in Europe, 0.8% in the UK, 0.3% in Japan and 0.4% in Australia. Credit spreads (over government bond yields) narrowed markedly in the first part of the quarter, in line with advances in equity markets. However, the return of risk aversion partially reversed this trend in the second part of the quarter.
The Australian dollar experienced a strong quarter, benefiting from the increase in commodity prices, particularly oil. The largest gain was achieved against the Japanese Yen, with a rise of 12% more than offsetting the decline recorded in the March quarter. Gains against other currencies, while more subdued, were still significant. This involved a rise of 5% against both the US dollar and Euro and a 4.5% gain against the Pound.
ARIA performance
Given this backdrop, the majority of ARIA options recorded negative returns in the June quarter. The worst affected were the Australian Shares and International Shares (unhedged) options – although the magnitude of negative returns was well below the double digit declines experienced in the March quarter. The Bonds / Fixed Interest option, Sustainable option and all other diversified options recorded very small negative returns. Positive returns were achieved by the Property, Cash and International Shares Options, with the latter benefiting from outperformance by a majority of our international shares managers.
For the full financial year 2007/08, double digit negative returns were recorded by the Australian Shares, International Shares (unhedged), Sustainable and International Shares options. Smaller negative returns were recorded by the three default options (PSS, CSS and Trustee Choice) and the Aggressive option. However, positive returns were achieved by the Property, Cash, Bonds / Fixed Interest, Conservative and Balanced options.
ARIA option performance for both the June quarter of 2008 and the full financial year 2007/08 is summarised in the following table.
ARIA performance ending June 2008 *
Option |
3 Months |
1 Year |
|
% |
% |
Trustee Choice |
0.1 |
-2.0 |
Conservative |
0.1 |
0.8 |
Balanced |
0.3 |
0.6 |
Aggressive |
-0.4 |
-5.2 |
Cash |
1.6 |
5.9 |
Bonds |
0.0 |
2.7 |
Australian Shares |
-2.8 |
-14.5 |
International Shares (unhedged) |
-3.9 |
-13.9 |
International Shares (hedged) |
0.2 |
-9.7 |
Property |
4.0 |
13.1 |
Sustainable |
-0.6 |
-12.1 |
* these figures are after fees and tax
Alison Tarditi
Chief Investment Officer
9 July 2008
