Quarterly Review July 2015

Posted in Wealth
22/07/2015 Level One

Market Update

The final quarter for the Australian Share market for the 2014/2015 financial year was negative with the ASX/200 closing at 5,459 points on 30 June 2015. The ASX/200 finished the previous quarter (31/03/2015) at 5,891.50 which equates to a drop of 432.5 points or 7.34% and effectively wiping off the gains for the first quarter for 2015. The ASX/200 increased from 63.3 points or 1.17% over the 2014/15 financial year.

Asset Class Returns to 30 June 2015

3 month %1 year
% pa
2 year
% pa
3 year
% pa
5 year
% pa
10 year
% pa
Australian bonds-
Australian property securities-2.320.215.618.314.22.3
Australian shares (accumulation index)-6.65.711.415.19.77.1
Global shares (hedged)
Global shares (unhedged)-0.124.322.


Asset class data: Bloomberg AusBond Bank Bill Index (cash), Bloomberg AusBond Composite 0+ Yr Index (Aust bonds), S&P/ASX300 A-REIT Accumulation Index (Australian property securities), , S&P/ASX200 Accumulation index (Aust shares) and MSCI All Country Indices hedged and unhedged in A$ (global shares hedged and unhedged).

The most significant contribution to the recent sell-off and relative underperformance stems from the heavy sell-off in the Banks sector from mid-April to early-June (albeit following a strong rally in the first quarter of 2015) as regulatory/capital concerns re-emerged and as Bank reporting season underwhelmed. Another noteworthy source of weakness in the Australian market has been the Consumer Staples sector on rising competition concerns.


The Year Ahead

Our equities research is sourced from UBS Wealth Management and we outline the following:

Best Prospects For 2015

We remain underweight in the Mining sector, REITs, Telcos, Consumer Staples and General Insurance.

We remain overweight USD earners, housing construction plays and Energy.

Australian Dollar Still Has Downside–Which Would Be Good For Earnings

While any additional long bond sell-off driven by a reassessment of the degree of Fed tightening should be contained, it should nevertheless provide the next down leg in the Australian dollar. We target 70c over the next 6-12 months. This should help the economy and the corporate earnings outlook though admittedly A$ weakness is an intermediate consideration for unhedged US$-based investors and for domestic investors weighing up the current merits of local versus overseas shares.

Year End Target

While the global backdrop is likely to remain relatively benign, our view is that local valuations are still somewhat elevated in an absolute sense. We don’t see big downside to earnings but equally they don’t see significant upside particularly with banks (capital) and miners (iron ore) likely to face further challenges. Our year end target for the ASX200 index is 5,800 (previous 5,900) which represents just over 2% potential upside from current levels (pre-dividends).


Economic Update

The Reserve Bank of Australia (RBA) reduced the cash rate further in May by 25 basis points to 2%. This decision came on the back of further declines in commodity prices and our falling terms of trade.

RBA Governor Glenn Stevens stated after their meeting in May “Low interest rates are acting to support borrowing and spending, and credit is recording moderate growth overall, with stronger lending to businesses of late. Growth in lending to the housing market has been steady over recent months. Dwelling prices continue to rise strongly in Sydney, though trends have been more varied in a number of other cities. The Bank is working with other regulators to assess and contain risks that may arise from the housing market. In other asset markets, prices for equities and commercial property have been supported by lower long-term interest rates.”

June and July saw rates left on hold and we still anticipate rates to be kept low for the remainder of 2015 at least.

Unexpectedly in May, unemployment dropped to 6% – a one-year low. The number of people employed rose by 42,000, almost 3 times the forecasted gain.

Consumer confidence has increased up to its highest point in 18 months (see chart at end). This is an encouraging sign for domestic spending in the period ahead. Economists are positive that this lift is the beginning of an upward trend. The decrease in the unemployment rate and improving labour market conditions across some industries are believed to be the driving force here. This will be a statistic to watch over the coming months.

Our gross domestic product (GDP) grew above expectations in the first quarter of 2015. The Australian Bureau of Statistics reported that GDP expanded 0.9% in the three months to the end of March, compared with 0.5% in the preceding quarter. The increased activity and demand for housing construction has played a significant part in this result.

The Australian dollar is still buying around US$0.76 at present. This remained reasonably steady over the last quarter, although mid-May saw the price hike to around US$0.80. To see most Australian trade-exposed industries the dollar needs to fall further; somewhere in the region of US$0.58 to US$0.70 would achieve this. Although this is a broad range this reflects the differences in competitiveness.

Tourism is still enjoying the decline in the dollar and the flow on effect is starting to show. Tourist facilities are getting a much needed revamp and planning and construction of new tourist facilities is underway. It is great to see the industry making up lost ground after almost a decade in the doldrums as a result of the high Australian dollar. Five years from now, Tourism, the industries that service it and the regions in which they are located, will be booming!

Meanwhile, recovery in new private capital expenditure in ‘other selected’ (mainly service) industries is hampered by weak revenue, profits and excess capacity. Until we see a sustained improvement in demand and profits, investment will remain weak.

This is not a steady state economy and growth remains below par. The fall in mining investment is a negative shock to growth, somewhat offset by continued strength in mining production, private consumption, and the recovery of dwellings investment. Broad based recovery will eventually transpire but it will take some time. It will start with the trade-exposed industries. The Tourism sector is first cab off the rank. But other trade-exposed industries will follow, tailed by a broadening of the recovery throughout the service industries.


Property Market Update

As subscribers to CoreLogic RP Data research we outline below a brief summary of their June Property Update:

June home value results capital city dwelling values finished the 2014/15 financial year on a strong footing, with dwelling values rising 2.0% over the June quarter and 9.8% higher over the year. The rate of capital gain was slightly higher over the second half of the year (5.1%) compared with the first half (4.5%) highlighting that the housing market has gathered some momentum during 2015. The previous 2013/14 financial year recorded a slightly higher rate of growth at 10.1%.

No doubt interest rates cuts in February and May have contributed in pushing capital gains higher.

Growth conditions had been moderating from April last year through to the end of January 2015. With the RBA cutting the cash rate in February, there was an instant buyer reaction across the Sydney and Melbourne housing markets where auction clearance rates surged back to levels not seen since 2009, capital gains once again accelerated and we are now seeing Sydney and Melbourne homes selling in record time; Sydney homes are selling in just 26 days and Melbourne homes are selling in 32 days.

The strength in the housing market has been diverse over the year. While Sydney and Melbourne have seen dwelling values increase by 16.2% and 10.2% over the financial year respectively, every other capital city has seen growth of less than 5% and dwelling values are down over the year in Darwin (-2.9%) and Perth (-0.9%).

The current housing growth cycle clearly highlights a divergence in capital gains across the capital cities. Since dwelling values started rising in May 2012, Sydney dwellings have seen a 43.1% surge in values and Melbourne values are up by 25.9%. Despite softer market conditions in Perth, dwelling values are currently up 12.8% over the cycle which represents the third highest growth rate across the capitals. Simultaneously, Brisbane’s property market has shown the fourth highest rate of growth at 12.4%, followed by Adelaide (10.4%), Hobart (9.6%), Darwin (8.9%) and Canberra (8.8%).

The three tiers of housing market performance can be best explained by economic and demographic factors where it’s no coincidence that New South Wales and Victoria are recording the strongest economic conditions coupled with the strongest rates of migration which is fuelling housing demand. These states are more sheltered from the mining sector downturn and have benefited from the strong multiplier effect of housing construction as well as a vibrant financial services sector.

The Perth and Darwin markets are weakening in line with the downturn in the resources sector and an associated weakening in infrastructure investment and a marked slowdown in migration. Brisbane, Adelaide, Canberra and Hobart are seeing softer economic conditions and population growth compared with Sydney and Melbourne, however housing markets have shown some level of growth over the year.

Looking at the performance of detached housing versus apartments over the financial year, houses are clearly outperforming units in the capital gains stakes. Over the financial year, house values were 10.4% higher across the combined capitals index while unit values increased by a much lower 5.6%. The same trend where houses are showing a higher capital gain than units is evident across each of the capital cities except Hobart and Darwin.

Today’s results confirm a scenario where detached housing outperforming apartments is most evident in Melbourne. Based on the results, Melbourne house values have shown a very strong 11.2% capital gain over the financial year while apartment values are up by only 2.4%.

The underperformance of units compared with houses is likely due to higher supply levels for units compared with detached houses. The Inner Melbourne unit market exemplifies the weakness in this sector where the latest CoreLogic RP Data ‘Pain and Gain’ report revealed that almost one quarter of all apartments across the Inner Melbourne region resold over the March quarter at a price that was lower than the purchase price.

Gross rental yields drifted another notch lower in June due to dwelling values rising at a faster pace than weekly rents. Currently, the typical gross yield for a capital city house is recorded at 3.5%, which is equivalent to the record low last recorded in 2007. The average gross yield on a capital city unit also fell over the month to reach 4.4%; the lowest gross apartment yield since 2010 and not far off the all-time low of 4.3% recorded in 2007.

It looks likely that the pace of capital gains will remain higher than rental growth which will push rental yields even lower over the coming months. Melbourne continues to hold the unfortunate title of the lowest yielding capital city, but if current trends continue, it won’t be long before Sydney overtakes Melbourne due to the substantially higher rate of capital gain in the face of comparatively low rental appreciation.

Brisbane is now recording the highest gross rental yield for apartments, at 5.4%, and the only capital city where gross rental yields have improved over the year has been Hobart which is now starting to rival Darwin as the highest yielding capital city for houses.

It is difficult to imagine Sydney maintaining such a rapid pace of capital gains. Not only is affordability becoming a challenge for many sectors of the market, but yields are substantially compressed, rents are hardly moving and investors are facing tighter financing conditions from lenders. In the absence of a trigger event, such as a sharp rise in the jobless rate, higher interest rates or an external shock, it is unlikely we will experience a significant correction in dwelling values. However, the longer this run of growth continues across our largest capital cities, the more susceptible the housing market becomes to changes in the economy or broadly across household finance.

Source RP Data


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