The Australian S&P/ASX 200 Accumulation Index fell 5.38% in September, which was the weakest monthly performance since May 2012.
Most major share markets weakened over the month. The Australian share market underperformed its global peers, weighed down by weak performance in the two largest sectors, Banks (which represent 30% of the Index) and Materials (16%).
A confluence of factors worked against the local market during the month. Regulatory concerns in the banking sector regarding capital requirements and lending restrictions, lower commodity prices (notably iron ore) and a weaker Australian dollar (AUD) were the key drivers of the local market’s underperformance.
The AUD fell 6.3% against the US dollar (USD) in September to close at USD 0.875 – its lowest level in four years. The AUD also weakened on a trade-weighted basis, suggesting the local currency’s weakness was not entirely due to a stronger USD. The fall in commodity prices this year seems to be finally catching up with the AUD. Currency weakness assisted the performance of Australian stocks with USD earnings.
The European Central Bank’s (ECB) decision to ease interest rates and announce an asset-buying program to head off deflation in Europe, and the prospect of higher interest rates in the US were the primary drivers of the USD’s strength over the month. A rise in US and Australian 10-year bond yields was a further negative for Australian high-yielding stocks. Australian economic data was mixed over the month.
Employment growth rebounded in August with a record number of 121,000 new jobs during the month (largely comprising part-time jobs). The unemployment rate fell to 6.1% from 6.4%. Building approvals and retail sales strengthened. Business confidence retraced some of its recent gains, but remains resilient. Consumer confidence fell a sharp 4.6% in September, effectively eroding the previous three months’ gains. June quarter GDP rose 0.5% (versus the very strong 1.1% in the previous quarter), producing an annual rate of growth of 3.1%. Most of the growth in the June quarter was due to a build up in mining inventories.
The Reserve Bank of Australia (RBA) kept interest rates on hold at 2.5% during the month, with the Bank continuing to cite that a period of stability in interest rates was appropriate. Later in the month, the RBA expressed concern about price pressures in the housing market, suggesting the possibility of more stringent lending standards to reduce the level of investor housing lending.
In the US, economic data on the whole continued to strengthen. June quarter GDP was revised upwards again from an annualised rate of 4.2% to 4.6%, with the main revisions occurring in business investment and exports. Manufacturing and consumer confidence were also much stronger over the month.
Concerns over the strength of the Chinese economy and financial stability increased during the month. Industrial production grew by a much weaker-than-expected annual rate of 6.9% (versus expectations of 8.8%), the official manufacturing Purchasing Managers’ Index fell to 51.1 from 51.7 and house prices in 70 medium and large cities fell for the fourth consecutive month.
All GICS level 1 sectors in the Index fell over the month. The largest detractors from the Index’s performance were the Banks, Materials and Energy sectors. The defensive Healthcare sector was the best performing sector over the month. Banks weakened largely on the increasing speculation of higher capital requirements and the possibility of tighter lending restrictions. A weaker AUD occurred coincidentally with the sector’s weakness, signalling that international investors were likely sellers of banking stocks. Commonwealth Bank, Westpac and National Australia Bank were the largest detractors from the sector’s performance.
Weakness in the Materials sector was driven primarily by mining stocks, which were weighed down by the weaker iron ore price. Ongoing concerns of excess iron ore supply and weak steel demand in China saw the iron ore price fall 11.8% over the month and 42.3% for the year to date. BHP Billiton was the largest detractor from performance, with the stock also weighed down by lower oil prices. Rio Tinto and Fortescue Metals Group were the next largest detractors from the sector’s performance.
Weakness in the Energy sector reflected lower oil prices, which weakened on reduced supply concerns and weak demand. Lower oil prices outweighed the earnings benefit of a weaker Australian dollar. Woodside Petroleum, Santos and Oil Search were the key detractors from the sector’s performance.
Healthcare stocks benefited from their defensive nature. Companies with foreign earnings exposure such as CSL, Resmed and Sonic Healthcare contributed to the sector’s outperformance.
The Australian economic outlook is expected to improve over next 12 months.
The transition to non-mining growth is slowly occurring. Consumption has increased. Housing approvals and dwelling construction have increased. The slowest component of growth has been commercial investment.
Broader business confidence has not been sufficiently swayed by lower interest rates to stimulate the so-called ‘animal sprits’ to offset the downturn in mining investment. Interest rates remain accommodative. Companies have very strong balance sheets, with low gearing and record levels of cash, so are well positioned to invest.
Recent weakness in the AUD will assist Australia’s economic recovery and be beneficial for Australian companies with offshore earnings. A lower AUD is critical in achieving a rebalancing in the economy away from a reliance on mining investment to other sources of growth.
The S&P/ASX 200 Index P/E currently stands at 14.5 times forecast earnings (12 months forward). The current forecast S&P/ASX 200 Index dividend yield stands at 4.9%, which is very attractive relative to the official cash rate of 2.5%. The global economic outlook remains mixed. Strength in the US and UK is countered by ongoing deflation concerns in Europe and economic system stability and slowing growth in China.
The US Federal Reserve is expected to complete the winding back of its asset buying program in October. The cessation of bond-buying support and potential change in Fed rhetoric has been a catalyst for the market’s pricing of US long bonds to unwind, and there is further to run yet. Yield-sensitive equities could continue to be vulnerable in an otherwise improving environment for equities.
Concerns regarding the strength of the Chinese economy and shadow banking risks remain. Real estate remains an area to watch closely, especially given the demand for steel and thus iron ore within this sector. Authorities have responded to the house price declines by easing lending restrictions. The Chinese Government is implementing a range of economic and financial reforms. The implementation of these reforms while also meeting their growth objective may prove challenging.