VicSuper’s member investment choice (MIC) options were all positive over the June 2016 quarter.
The performance reflected a rebound in returns across Growth assets in particular with the Australian share market (S&P/ASX 300 Accumulation Index) gaining 4% over the quarter while the US share market (S&P 500 Index) rose by 1.9%.
The options with the higher exposure to Growth assets (Equity Growth, Equity Growth Sustainability and Australian Shares) were the best performers for the quarter.
Asset class performance for the June 2016 quarter
Chart 1: Major Index Returns (VicSuper’s Asset Class Benchmarks)
Source: Bloomberg, Barclays, MSCI
Global and Australian Equities
The Australian equity market (ASX300 Accumulation Index) was up 4.0% for the June Quarter, outperforming the US (S&P500 +1.9%), Japan (Nikkei -7.1%) and major European markets (CAC -3.4%, DAX -2.9%), with the surprising exception being the UK (FTSE +5.3%).
Equity markets continued to be volatile in the second quarter. The biggest news for the quarter was the shock outcome of the Brexit vote which contributed to increased global volatility.
Polling of voting intentions prior to June 23rd indicated that voting on the referendum for the UK to leave or stay within the European Union (EU) would be close. On the other hand, financial markets were confident that the UK would remain in the EU and that sentiment was “priced” into stock, bond and currency markets.
As we know the “Exit” campaign was successful and caught investors off-guard and the subsequent fall in global markets occurred swiftly as a result.
Not surprisingly, the UK equity market (FTSE100) dropped -3.2% on the day. The GBP fell against most other currencies, touching a 31-year low of US$1.31. On the other hand, the Japanese Yen rallied strongly against other currencies, finding favour as a “safe-haven” currency while the Australian dollar appreciated 3% against the USD.
The direct economic impact of Brexit on Australia should be small given the limited trade with the UK. With the exception of the period immediately following the Brexit outcome, the second quarter of 2016 was fairly uneventful for equity prices. Broad market indices were confined to a relatively narrow trading range during most of the quarter, with the Brexit result surprising the market and sparking a short-lived sell-off. Markets priced in Brexit very quickly and have since recovered to pre Brexit levels.
Commodities shrugged off the Brexit vote and rebounded after an initial downward reaction. Gold prices rose strongly on safe-haven buying while iron ore prices rose as Chinese economic data continued to be modestly supportive of steel production.
Economic data releases included a worse than expected US Non-Farm Payrolls report^ with an increase of 38,000 jobs, against an expected 160,000. The US non-farm payrolls number has since been revised down to 11,000. In Australia first quarter 2016 GDP grew by 3.1% (year on year).
Oil rose to a seven-month high in June, as balance appears to be returning to the market faster than expected as supply is reduced. Brent crude price closed at USD 48.37 per barrel.
^ Non-Farm Payrolls report represents total number of paid workers in any business and excluding farm workers, private household employees, government employees or non-profit organisation employees. The data is an indicator of health and economy.
Emerging Market Equities
The MSCI Emerging Markets Index gained 4.1%(USD) in June and 0.80%(USD) for the June 2016 quarter.
In China, policymakers continue to attempt to engineer a soft landing from an export-driven to a more sustainable consumption-driven model. China has also been devaluing the yuan, leading to that currency’s lowest level against the U.S. dollar since December 2010. On 27 June the Chinese Central Government devalued the RMB by almost 1% to a five and a half year low against the dollar, the biggest downward move since August 2015.
Australian and International Fixed Interest
Although the second quarter began on a positive note, the 23 June UK vote to exit the European Union (EU) dominated the quarter in fixed income markets. The ‘Leave’ outcome came as a surprise to many investors with portfolios largely positioned for a ‘Remain’ result. As a consequence, greater volatility followed and demand for government bonds increased.
Ten year UK government bond (gilts) yields fell from 1.42% at the end of the first quarter (Q1) to 0.87% at the end of Q2 (consistent with the inverse relationship between bond prices and yields). The strongest gains for UK government bonds also known as ‘gilts’ were in the longer dated maturities which are generally more sensitive to plunging yields. The Bank of England responded to the unexpected ‘Leave’ vote by reassuring investors that additional monetary policy stimulus could be provided to support the domestic economy.
The results of the UK Referendum also reverberated throughout global bond markets. Expectations for an increase in US rates were pared back in the lead up to the referendum with the US Federal Reserve Chair citing the risks of a ‘Brexit’ on global growth. This concern was echoed by US Fed Board Governors following the ‘Leave’ vote. Consistent with previous quarters, yields on US government bonds with mid and long term maturities moved lower than yields with shorter term maturities which led to a flattening of the yield curve. This was primarily driven by an increase in demand for mid to long term government bonds in safe haven markets with a positive yield. Safe haven markets such as Germany and Japan are currently offering negative yields.
Yields on Australian bonds also moved lower over the second quarter and a slight flattening of the yield curve ensued. Australian 10 year bonds registered record lows in June falling below 2%.
Chart 2: Australian Yield Curve Movement - June 2016 Quarter (%)
US government bond yields responded to the political and economic uncertainty falling to 1.47% at the end of the second quarter from 1.77% at the end of the first quarter. German Bund yields followed suit, falling to -0.13% at the end of the second quarter from 0.15%.
The Reserve Bank of Australia (RBA) reduced the official cash rate to a record low of 1.75% in the second quarter. Despite being reasonably satisfied with the rebalancing of the economy the cut underscores the RBA’s commitment to ensuring inflation returns to the 2% to 3% target band after Q1 inflation fell well below target. The strong Australian dollar was also a contributing factor to the rate cut. The RBA statement made no mention of a further bias toward easing interest rates.