General Summary 

The economic data released around the world in the December quarter showed that

  • The Australian economy remains soft with both business and consumer confidence declining as the unemployment rate has risen and inflation has been subdued. The Reserve Bank of Australia refrained from further cuts in the cash rate which still stands at its record low of 25%.

  • The US economy continued to post decent numbers with firmer economic growth and the unemployment rate moving below 6%.

  • The core European economies also recorded both slower growth and lower inflation so that the Eurozone as a whole is now on the border of outright deflation; the European Central Bank announced a new programme of quantitative easing to address these issues.

  • In Japan, the economy has slipped back into recession. Prime Minister Abe won a snap election in December to renew his mandate for economic reform and the Bank of Japan announced a new open-ended quantitative easing programme.

Main talking Points

The December quarter 2014 saw financial markets around the world revisit the “growth shock” they experienced in the September quarter. This time however the markets’ fears were driven by sharp declines in the price of oil which fell 40% in the quarter. The markets interpreted this to be a sign of weaker global demand and therefore slower economic growth. However, the decline in the price of oil has really been driven by increased supply by OPEC nations. This in turn has partly been in response to the increased supply of competing energy products from within America. It has also been due to non-OPEC nations, notably Russia and Brazil, increasing their supply to try to maintain desperately needed foreign currency revenues of the local economy have slipped into recession.

Global equity markets initially fell along with bond yields in response to these forces. However by the end of the quarter a number of equity markets have recovered their losses and the US market had posted a new all-time high. Bond yields however remained relatively low. This is partly in response to the quantitative easing programmes announced in Europe and Japan and partly to the markets and not believing the US Federal Reserve will lift interest rates as quickly as they have said they will.

The Australian equity market did not fare as well as some others around the world partly because of our exposure to resource stocks and partly due to deteriorating sentiment about the domestic economy. Households remain cautious in the face of the rising unemployment rate and business confidence has slipped in the face of gridlocked government in Canberra. A number of commentators revised down their prospects for economic growth in Australia in 2015 and some called for the Reserve Bank to cut interest rates further. However, the Governor of the Reserve Bank poured cold water on these views and said he would rather see a weaker exchange rate contribute to loosening monetary conditions rather than a lower cash rate.

Market Performance

The chart below summarises the returns for selected markets in the December quarter 2014.

A number of world equity markets rose in the December quarter after initially declining. Best performers included the Japanese Topix index (up 6.2%) and the S&P 500 (up 4.8%). However, quite a few markets declined in the quarter including the Spanish Ibex index (down 5%) in the French CAC index (down 3.3%). In Australia, the ASX 200 index rose 3.1%.

Yields on 10 year government bonds fell in most countries. In the United States, the 10 year yield fell 32 basis points to 2.17%. The equivalent yield in Australia fell 67 basis points to 2.82%.

In the currency markets, the $A fell 6.6% against the US$ in the quarter to US$0.817. The US dollar rose 9.2% against the Japanese Yen.

In commodity markets, the price of gold fell slightly to US$1199 per ounce while the price of oil fell 40 % to US$56 per barrel.DAC December 2014 graph 1

Asset Allocation and Portfolio Construction

Given the above and the Investment Committee outlook for the period ahead, asset allocation and portfolio construction considerations include:

  • Holding international investments on an unhedged basis;
  • Increasing exposure to equities in selected portfolios;
  • Maintaining underweight exposures to bond and credit markets;
  • Increasing short-term money market allocations as a result of a reduction to bonds; and
  • Maintaining a neutral stance on property.