Economics overview

−US: Preliminary US GDP statistics for the June quarter werereleased and showed that the economy grew at an annual paceof 4.1% in the three months ending 30 June 2018.
−This encouraging statistic followed a slightly weaker reading inthe March quarter. Viewed together the two releases confirm theeconomy performed well in the first half of 2018, growing at apace that was broadly in line with consensus expectations.
−The improved performance in the June quarter was supported bysolid consumer spending and higher soybean exports. Businessspending slowed during the period.
−The value of exports rose 9.3% from a year earlier, comparedwith a 3.6% increase in the previous quarter. Imports moderatedover the same period, resulting in a strong influence from tradeoverall. In fact, the contribution of trade to GDP growth in the June quarter was the highest since 2013.
−Headline CPI again edged higher, to 2.9%. Ongoing pricingpressures in the economy are supporting the case for officialinterest rates moving back towards neutral.
−Housing starts data released in mid-month was particularly weak,with June starts 12.3% below the May level. The residentialconstruction market may be starting to feel the impacts of higherinterest rates.
−US interest rates were left unchanged at 2.00% in July, althoughfurther hikes are anticipated before the end of 2018.

−Australia: The Reserve Bank of Australia (RBA) again leftinterest rates on hold at 1.50%, extending the record periodwhere policy has been unchanged.
−The chances of official borrowing costs being amended in theforeseeable future remain low, particularly with inflation onlyapproaching the bottom of the RBA’s 2-3% target band. AnnualCore CPI was reported as 1.9% in the June quarter, althoughhigher petrol prices helped lift headline inflation to 2.1%.
−Employment trends remain encouraging, with more than 50,000jobs created in June. The official unemployment rate remainedsteady at 5.4%, however, and there is currently insufficient wagepressure to concern policy makers.

−New Zealand: Inflation picked up to 1.5% yoy in the June quarter, driven by higher food and transport prices. The increase wasslightly short of consensus expectations, however, and is unlikelyto be a concern for policy makers. Interest rates remain at 1.75%.
−In spite of loose monetary policy, business confidence fell to a 10-year low in July. Inflationary forces could lose momentum ifsubdued confidence levels result in investment plans beingdelayed or cancelled.

−Europe: Economic activity in the June quarter did not rebound asmany economists had anticipated.
−In fact, GDP growth in the Euro area was just 0.3% in the period.This was below consensus expectations and dragged the annualpace of growth down to 2.1%, from 2.5% previously.
−In spite of subdued economic conditions, some inflationarypressures appear to be emerging; the latest estimates suggestheadline CPI in Europe has risen above 2.0%.
−UK inflation data for June came in below expectations, whicharguably should reduce the likelihood of an increase in officialinterest rates by the Bank of England (BoE).
−However, previously hawkish comments from BoE officials haveseen the market retain a 91% chance of a hike in early August.
−No meaningful progress has been made recently in the prolonged ‘Brexit’ process and the UK’s proposed withdrawal from theEuropean Union.

−Asia: The Chinese economy grew by 1.8% in the June quarter,compared to a 1.4% expansion in the first three months of theyear. The economy advanced 6.7% in annual terms, which wasin line with market expectations.
−For 2018 as a whole, the Chinese government is targetingeconomic growth of around 6.5%.
−During the month officials announced that China is taking stepsto contain debt and leverage levels in the economy in order toreduce financial risks. Rising defaults among Chinese corporatebond issuers earlier in 2018 had become a concern for investors.This news was well received by investors – the stock marketstabilised in July, having lost more than 20% of its value betweenmid-January and the end of June.
−Elsewhere in Asia, the Bank of Japan lowered inflation forecastsout to 2020, suggesting monetary policy settings will not betightened and that bond yields will remain anchored at low levels.
−With inflation running at just 0.7% yoy, Japanese interest ratesremain at zero and a Quantitative Easing program is still in place.
−GDP data for the June quarter is due on 9 August. A contractionwould see the economy enter into a technical recession, followinga negative growth reading in the March quarter.

Australian dollar
−The Australian dollar traded in a reasonably tight range againstthe US dollar, fluctuating between 0.735 and 0.745 for most of the month.
−At the end of July, the Australian dollar bought 0.742 US dollars;an exchange rate that was almost unchanged from the end ofJune.

Commodities
−Most commodity prices finished the month lower as the USannounced a new set of tariffs on Chinese goods. China isexpected to reciprocate by imposing further tariffs of its own ongoods imported from the US.
−Concerns also mounted over the outlook for global growth, whichhas been driving demand for commodities in recent months.
−Oil (-6.5%) took a breather after posting strong gains in recentmonths and reaching multi-year highs. Thermal coal (-11.3%)also retreated as deficit concerns subsided.
−Precious metals were mostly lower, with gold (-2.3%), silver(-3.6%), palladium (-2.6%), and platinum (-2.4%) all finishing innegative territory.
−Most industrial metals lost ground on concerns around globaleconomic growth, including lead (-11.0%), zinc (-7.9%), copper(-5.2%) and aluminium (-4.3%).
−Iron ore (+0.7%) edged higher as the drawdown of Chinese steelinventory continued, given stable demand and supply disruptionsfrom China’s environmental crackdown.

Australian equities
−After some volatility, the S&P/ASX 200 Index finished the monthup 1.4%. Investors focused on improving domestic economicdata, as well as the upcoming ‘earnings season’.
−Telecoms stocks made a noteworthy comeback in July, rising7.9% reflecting strong recoveries in TPG Telecom and Telstra.
−Technology stocks struggled following poor results from US-listedFacebook. Utilities also underperformed after the ACCCproposed wholesale and retail electricity price reforms.
−Small caps underperformed, with the S&P/ASX Small OrdinariesAccumulation Index declining -1.0%. Toilet tissue and hygieneproducts supplier, Asaleo Care lost nearly half of its value afterreleasing disappointing preliminary half year results and loweringfull year earnings guidance.

Listed property
−The S&P/ASX 200 A-REIT Index returned 1.0% in July.
−Diversified A-REITs (3.4%) was the best performing sub-sector,while Industrial A-REITs (0.1%) was the weakest.
−M&A activity remained a key driver, with Blackstone’s $3.1 billiontakeover bid for Investa Office Fund being labelled unfair butreasonable by independent expert KPMG. Elsewhere, Hometownlodged a bid for Gateway Lifestyle, with Brookfield reported tohave walked away from its proposed transaction.
−The strongest performers were Mirvac (5.1%), Stockland (4.5%),and National Storage REIT (4.0%). Mirvac benefited fromsecuring Suncorp as a major tenant at its proposed officedevelopment in Brisbane.
−Underperformers included Scentre Group (-3.2%), Charter HallLong WALE REIT (-3.2%), and Shopping Centres Australasia(-2.0%). Scentre shares fell following earnings downgrades frommultiple brokers, despite expectations that FY18 earningsguidance would be reaffirmed following the Group’s recent 50%acquisition of Eastgardens, a shopping centre in Sydney.
−Globally, major property market returns underperformed broaderequity markets. The FTSE EPRA/NAREIT Developed Indexreturned 2.5% in USD terms.
−In local currency terms, Hong Kong (2.8%) was the bestperforming market, while the UK (-0.6%) was the worst.

Global equities
−Stock markets fared well in July, with positive economic news anda bright start to the US earnings season supporting sentiment. Allmajor markets registered positive returns.
−US technology earnings unsettled investors in the final days ofthe month, however, dampening returns from the MSCI WorldIndex to 2.5% in Australian dollar terms.
−The German DAX finished the month up 4.1%, as the US and EUappeared to reach a trade truce towards month-end. Having been hit hard over the potential US trade war, rebounds in carmakersVolkswagen and BMW helped the German bourse to outperformother major equity markets worldwide.
−The Japanese Nikkei rose 1.4% in local currency terms, but wasthe worst performer among major markets. A number of largelisted technology stocks were caught in the Facebook-inspiredglobal sector downturn.
−Emerging markets added 1.8% in local currency terms, supported by a sharp rebound in Brazilian stocks. The MSCI Brazil jumped9.2% in local currency terms, partly reflecting easing tradetensions.

Global and Australian Fixed Interest
−News flow affecting global bond markets moderated in July, withfew major themes influencing market sentiment.
−Volatility was reasonably low, certainly when compared to theheightened level of yield fluctuation we’ve seen in recent months.
−The rise in yields in the second half of July was mostly related toincreased attention on the Bank of Japan (BoJ) after officialsindicated they were considering a change in policy settings.
−If Japanese Government Bond yields were to rise, local investorsinvested in overseas bond markets might liquidate some of thoseinvestments and reallocate the proceeds into JGBs.
−US Treasury yields are expected to continue to test their recenthighs as the Federal Funds rate is increased.
−This is likely to support higher yields in other regions, particularlythose where monetary policy is also being tightened.
−Negative investor sentiment associated with the withdrawal ofliquidity from central banks remains a key risk to this scenarioplaying out as expected.

Global credit
−Credit performed well in July, providing some long-awaited goodnews for investors. Investment Grade spreads narrowed 12 bps,closing at 1.13%. This followed five months of persistentweakness, where spreads had widened by around 40 bps.
−Another solid set of quarterly earnings announcements fromlisted US companies supported sentiment towards issuers inmost regions and industry sectors. Disappointing earnings in thetech sector did not have a significant influence on the market asa whole, as credit issuance is limited in this area of the market.
−There was particular respite for Asian issuers, which haveunderperformed recently due to trade concerns. Chineseauthorities appear to be easing back on measures that had beenimplemented to contain credit growth.
−The general optimism and healthy appetite for risk extended intothe High Yield market too, with yields closing 24 bps lower, at2.95%. Following the pull-back in July, yields in the High Yieldsector are close to their average level over the past 12 months.

Chart of the Month – Could the US Treasury yield curve invert?
In these bulletins, we aim to share interesting observations from global investment markets. This month we look at the US Treasury yield curve, which has flattened substantially in the past year. Might we be about to see the curve invert, with short-term yields rising above longer-term yields? The green line shows the US Treasury yield curve at 31 July 2018. The yellow line shows the curve at 31 July 2017. The yellow bars show the change in yields over the year for bonds with different maturities. Source: Bloomberg.

As the chart shows, 2-year US Treasury yields rose 132bps, to 2.67% in the year to 31 July 2018, primarily due to rising inflation and increases to the Federal Funds rate. 10-year yields rose over the same time period too, albeit by a smaller 68bps, to 2.97%. The curve has flattened as a result and the spread between 2-year and 10-year yields has narrowed to 30bps. This is the lowest level since 2007, before the GFC.

The narrowing between 2-year and 10-year yields has attracted a great deal of attention because an inverted Treasury yield curve has historically been a fair forward indicator of economic recession in the US. Prior to 2017 the curve inverted in 2000, 1989 and 1980 – on each occasion a recession followed shortly thereafter.

Monetary policy – both actual and anticipated – remains the primary driver of the curve shape. As a general rule:
-When the Federal Funds rate (which is an overnight rate) is below neutral, the curve tends to be steep.
-When the Federal Funds rate is well above neutral, the curve is more likely to be inverted.
-Policy makers typically hold the Federal Funds rate above neutral when they are attempting to slow the economy or controlinflation. This partly explains why inverted yield curves have often preceded economic downturns.

As the Chairman of the Federal Reserve has pointed out, “It’s really not the situation we are in now”. Inflation is currently under control and the Federal Funds rate remains below neutral. Only time will tell whether the curve will invert again this year and, more importantly, whether it will prompt a reversal in the recent economic expansion in the US. We do not currently believe this is likely, as a significant depression in the ‘term premium’ at the longer end of the curve appears to have been a major contributor to recent curve flattening.

We have seen compression in the spread – also referred to as the term premium – owing to a combination of:
-Bond purchases from central banks globally;
-The low inflation environment globally; and
-Significant forward guidance on interest rates from members of the US Federal Reserve Board.

Effectively, all of these factors lower the compensation required for investors to position bond portfolios at the longer end of the curve. As a result, the near inversion of the yield curve may not have such negative implications for the US economy as it has in the past.

*Source: FactSet, as at 31 July 2018.
Want more information?
Please speak with your financial adviser Mark Giles Mark Giles of Complete Financial Solutions (WA) – Financial Planning (ABN26 050 157 938) is an authorised representative of Financial Wisdom Limited (ABN) 70 006 646 108 AFSL 231138). Alternatively visit our website at completefinsol.com.au or contact Colonial First State Investments Limited at colonialfirststate.com.au or phone 13 13 36. © Colonial First State Investments Limited ABN 98 002 348 352 AFS Licence 232468. This document has been prepared by Colonial First State Investments Limited ABN 98 002 348 352, AFS Licence 232468 (Colonial First State) based on its understanding of current regulatory requirements and laws as at 6 October 2016. This document is not advice and provides information only. It does not take into account your individual objectives, financial situation or needs. You should read the relevant Product Disclosure Statement available from the product issuer carefully and assess whether the information is appropriate for you and consider talking to a financial adviser before making an investment decision.

Economics overview

• US: The Federal Reserve raised interest rates by 0.25% as anticipated, to a new target range of 1.75% to 2.00%. Consensus expectations suggest rates could be increased twice more in the remainder of 2018, before four further hikes next year.
• Final GDP data confirmed the economy expanded 2.0% in the year ending 31 March 2018.
• The US employment market remains buoyant. Non-farm payrolls data showed a 223,000 increase in jobs in May. The official unemployment rate fell to 3.8%, the lowest level since the 1960s.
• Tighter labour market conditions have not resulted in significant wage pressure. Average hourly earnings rose 2.7% in the year to 31 May 2018; slightly below inflation. The Consumer Price Index – arguably the best indicator of prices for most households – rose at an annual pace of 2.8% in May, a six-year high.
• Core PCE – the inflation measure used by the Federal Reserve when setting interest rates – also rose, to the target 2.0%.

• Australia: GDP data showed the Australian economy grew by 3.1% in the year ending 31 March 2018. This pace was above consensus forecasts. The acceleration in growth was fuelled by a recovery in export volumes. Consumer spending was weak and funded by a savings rate that fell to its lowest level since 2007.
• Australian inflation remains below 2%. The Reserve Bank of Australia again left interest rates on hold at 1.50% against this background.
• The unemployment rate unexpectedly dropped to 5.4%, helped by a sizable gain in part-time employment.
• Other data released showed that the Australian population grew by 1.6% in 2017. Australia continues to see net positive overseas migration, with migrants accounting for over 60% of the growth.
• Victoria appears to be a particularly appealing destination, with the state population rising by 2.3%.

• New Zealand: GDP data for the first three months of 2018 showed the economy expanded at an annual pace of 2.7%, a slight deceleration from the December quarter.
• A dissection of the data highlighted that growth was driven by services sectors and rising production of dairy products. Conversely, there was a slowdown in the construction sector.
• The GDP data supports a view that the Reserve Bank of New Zealand is unlikely to raise interest rates until 2020. In fact, some observers are suggesting a cut is possible in the months ahead.
• Later, data showed that exports rose 10.4% in the year ending 31 May 2018, the second fastest pace on record. This was partly due to a 17% yoy rise in meat exports and strong lumber exports.

• Europe: The European Central Bank (ECB) announced an intention to withdraw its Quantitative Easing program by the end of 2018.
• Rather than removing the stimulus package at the end of September 2018 as originally planned, the Bank will halve bond repurchases – to a rate of €15 billion per month – for the final three months of the year.
• Official interest rates will remain zero until mid-2019 at the earliest. Investors are not expecting a hike until September 2019.
• The announcement came at a time when the European economy is showing signs of weakness. This prompted some observers to suggest that the move was based on political motivations rather than economic indicators.
• In the UK, 146,000 new jobs were created between February and April; more than economists had anticipated.
• The official UK unemployment rate remained at 4.2%, the lowest level since 1975. In spite of the buoyant employment market, wage growth eased to 2.8%, suggesting there remains some spare capacity in the economy.
• The Bank of England left interest rates on hold at 0.50%. Three of the nine-member Committee voted for an increase, however, raising the prospect of a hike in the months ahead.

• Asia: Unlike the ECB, the Bank of Japan (BoJ) remains committed to its own Quantitative Easing program.
• Currently at 0.7% yoy, inflation has been trending lower suggesting the program could remain in place for an extended period. In fact, the BoJ lowered its inflation forecasts during June.
• In China, some observers suggested that a prolonged trade conflict with the US could shave 0.5% from GDP growth.
• Escalating trade tensions between China and the US weighed on equity markets in the region. The Shanghai Composite Index, for example, is down 20.0% since January. China’s currency also suffered its largest ever monthly fall against the US dollar in June.
• The much anticipated North Korea/US summit was held in Singapore in mid-June. This event attracted plenty of headlines, but did not affect equity or bond markets in the region.

Australian dollar

• The diverging outlook for interest rate policy in the US and Australia was reflected in foreign exchange markets.
• The Australian dollar depreciated by 2.2% against the US dollar in June, extending recent weakness.
• Since Australia Day on 26 January 2018, the ‘Aussie’ has lost more than 8% against the US dollar.

Commodities

• Commodity prices were mixed, with metals falling, energy prices rising and iron ore little changed.
• Zinc (-4.9%), aluminium (-4.5%), copper (-3.5%) and nickel (-1.9%) all fell, as trade concerns between the US and China cast a cloud over the economic growth outlook and the demand for industrial metals.
• Gold finished -3.8% lower amid ongoing strength in the US dollar. Silver (-3.1%), palladium (-3.1%) and platinum (-6.1%) also fell.
• Oil prices rose, with WTI Crude adding 10.7%. Prices were supported by ongoing OPEC supply restrictions.
• Coal rose for the second consecutive month, with coking coal and thermal coal adding 4.4% and 3.9% respectively.
• Iron ore edged 0.8% higher, as the drawdown of Chinese steel inventory continued on supply disruptions from China’s pollution crackdown.

Australian equities

• The S&P/ASX 200 Index performed well in June, returning 3.3% and rising to a 10½ year high. This impressive performance was driven by a combination of a weakening Australian dollar, which fell to 18-month lows and a ‘relief rally’ in Australian banks.
• With the exception of Telecoms, all sectors registered positive returns. Energy (7.8%) and IT (6.3%) outperformed and helped drive a wedge between value and growth stocks (see Chart of the Month). Telecoms declined another -5.8% in June, closing FY18 as the laggard, falling -23.2%.
• All constituents of the Energy sector rose as higher oil prices provided a tailwind for the sector. Caltex Australia was the best performer, rising more than 10% after it released updated first half earnings guidance for 2018, which detailed a 49% annual improvement in net profit after tax.
• Small caps underperformed their large cap counterparts, with the S&P/ASX Small Ordinaries Accumulation Index rising 1.1%.
• Gateway Lifestyle, Amaysim Australia and Liquefied Natural Gas were among the best performers, each rallying more than 30%.
• June concluded one of the strongest three years of small cap outperformance since the inception of the Index in March 2000. In the three years ending 30 June 2018, small cap returns exceeded returns from the S&P/ASX 100 Index by 6.4% pa.

Listed property

• The S&P/ASX 200 A-REIT Index had a solid month in June, returning 2.2%. Industrials (4.5%) was the best performing sub-sector, while Diversified (0.5%) was the weakest.
• Merger and acquisition activity was a key driver, with Blackstone and Investa Office Fund entering a scheme of arrangement, and Hometown and Brookfield both making all-cash bids for Gateway Lifestyle.
• The strongest performers were Viva Energy REIT (9.8%), National Storage REIT (6.9%), and Charter Hall Long WALE REIT (6.4%). Viva Energy REIT benefited as its largest tenant and shareholder, Viva Energy, secured strong cornerstone interest for its upcoming IPO.
• The weakest performers were Mirvac (-3.0%), Stockland (-1.1%), and Unibail-Rodamco-Westfield (-0.3%). Mirvac fell heavily on concerns over the company’s exposure to residential property developers in Sydney, who are facing lower prices amid tighter credit conditions.
• Globally, major property market returns continued to outpace broader equity markets. The FTSE EPRA/NAREIT Developed Index returned 1.6% in USD terms. In local currency terms, the US (4.2%) was the best performing market, while Hong Kong (-4.1%) was the worst.

Global equities

• Global equity markets had a bright start to the month, rising almost 4% on positive economic news in the US, before trade tensions undermined market confidence. The MSCI World Index slipped back to finish the month up only 2.4% in AUD terms.
• In FY18 as a whole, the Index added 16.0%, beating the return from FY17. However, market joy was not well spread. Financials and some defensive sectors were left behind and value stocks suffered their worst year since the GFC (see Chart of the Month).
• Among major markets, the S&P 500, FTSE 100 and Nikkei 1000 were all little changed, returning 0.6%, -0.2% and -0.9% respectively, in local currency terms. The German DAX lagged, down -2.4% in euro terms.
• Emerging Markets underperformed their developed market counterparts over both the month and the year. The MSCI Emerging Markets Index returned -1.8% in June and 12.7% in FY18 in AUD terms.
• Investors are particularly concerned by countries with widening current account deficits and/or high levels of USD denominated debt. These markets appear susceptible to a combination of rising US interest rates and a strengthening US dollar.
• Asia was the worst performing region over the month, however, with China suffering from a combination of a weaker equity market and a falling currency. Investors appear to be fleeing the deteriorating economic outlook – exacerbated by fears of further trade barriers being erected between China and the US.

Global and Australian Fixed Interest

• Global bond yields continued to trade in reasonably wide ranges, but closed the month little changed in most markets. In the US, 10-year yields rose towards 3.0% in early June, before reversing and closing the month unchanged at 2.86%.
• Japanese 10-year yields were also unchanged in June. UK 10-year gilt yields rose 5 bps, while 10-year yields in Germany and Australia closed 4 bps lower, at 0.30% and 2.63%, respectively.
• The increase in bond market volatility in 2018 is arguably attributable to the removal of liquidity by central banks.
• Investors have been able to shrug off negative news flow in recent years, safe in the knowledge that markets would be supported by global central banks’ extremely accommodative policies. This sentiment is changing as policy settings are being reviewed, contributing to volatility in yields as investors digest economic and geopolitical news.

Global credit

• Credit markets were hampered by trade concerns, with the US and China each implementing new tariffs on a wide range of goods imported from one another.
• Thus far, investors have tried to estimate the likely impact on individual issuers. German car maker Daimler, for example, has suggested that lower Chinese sales of Mercedes vehicles manufactured in the US will result in lower profitability.
• These concerns saw investment grade credit spreads widen by 7 bps, to their highest level since late 2016. High yield spreads also closed the month 7 bps wider. Asian issuers performed particularly poorly, reflecting trade concerns.
• There was a reasonable level of issuance ahead of a seasonal slowdown during the northern hemisphere summer holiday season. Issues of around US$15 billion from both German healthcare giant Bayer and US retailer Walmart were among sizeable deals that came to market in June.
• Collectively, global corporates still have significant funding requirements in the remainder of 2018. The pace of new issuance is expected to pick up again in September.

Chart of the Month – Where’s the value premium?

In these bulletins, we aim to share interesting observations from global investment markets. This month we look at the ‘value premium’ since the inception of the MSCI Australia Value and Growth indices. We conclude that you might be better off with a balanced exposure to both styles rather than endure the return volatility of a single style bias.

US economists Fama and French are credited with first identifying the premium associated with investing in value stocks over the longer term. Using the MSCI Australia Large Cap Value and Large Cap Growth indices, we have looked at the relative performance of value and growth stocks each financial year since the inception of these indices in May 1994. The chart shows that there have been years in which the MSCI Australia Large Cap Value Index has strongly outperformed its growth counterpart – particularly during the “Tech Wreck” of 2000/2001 when Australian value stocks outperformed by almost 40%. Global value stocks were also outperforming strongly at this time. But you don’t have to be a Nobel Laureate to also know that what goes up – also tends to go down and during the depths of the Global Financial Crisis (GFC) over 2007/08, value stocks in Australia underperformed growth stocks by just over 30%.

*: The Australian Value Premium is the difference between the MSCI Australia Large Cap Value Index and the MSCI Australia Large Cap Growth Index.
**: The Global Value Premium is the difference between the MSCI World Value Index and the MSCI World Growth Index.

The value premium in Australia over the last 24 years has certainly been volatile, but if you have been patient and able to withstand the extreme swings in relative returns, you would have enjoyed a premium of 3%pa by investing in value stocks (as represented by the MSCI Australia Large Cap Value Index) as opposed to growth stocks (represented by the equivalent growth index). However, the benefits appear to have been eroding over time. In the second half of the period covered by the chart – from June 2006 to June 2018, the value premium had fallen away to a meagre 0.2%pa and over the last five years, that premium has turned around to become a deficit – growth stocks have outperformed by 0.4%pa.

Have investors been bidding up value stocks too much as they seek the premium identified by Fama and French? Or was there ever a premium at all? Jack Bogle, founder of the Vanguard Company, one of the largest asset managers in the world, has argued that no such premium exists and that Fama and French’s results are period dependent. Looking at the equivalent results across global stocks, one might agree with Mr Bogle. Global growth stocks have outperformed their value counterparts over 24 years (albeit by a paltry 0.1%pa), over 12 years (by almost 3%pa) and over the last five years (by 0.3% pa). Indeed 2017/18 has been the worst financial year for value stocks here and overseas since the GFC.

What do we conclude from this? Our Realindex team, which seeks to gain exposure to a variety of styles, including value, would point to the extreme underperformance of value over the last year and observe that these stocks are looking very cheap – offering an opportunity to benefit from the inevitable recovery. Meanwhile, our Australian Equities Growth team argues the notable outperformance of their highest conviction growth stocks merely reflects strong recent earnings growth and the market’s forward year expectations of their future growth being more than double that of the S&P/ASX 2001. Both arguments have merit, but one may be better off with a mix of value and growth as the benefits of exposure to one style alone appear to be outweighed by the volatility you have to endure in waiting for that single style premium to materialise.

The Growth team’s extensive broker database shows the weighted average earnings growth of stocks in their concentrated strategies are 24.56% (latest 12 months) and 9.04% (FY1 estimate) versus the equivalent for the S&P/ASX 200 being only 17.20% and 4.49% respectively.

MARKET WATCH DATA SHEET

 

Want more information? 

Please speak with your financial adviser Mark Giles Mark Giles of Complete Financial Solutions (WA) – Financial Planning (ABN26 050 157 938) is an authorised representative of Financial Wisdom Limited (ABN) 70 006 646 108 AFSL 231138). Alternatively visit our website at completefinsol.com.au or contact Colonial First State Investments Limited at colonialfirststate.com.au or phone 13 13 36. © Colonial First State Investments Limited ABN 98 002 348 352 AFS Licence 232468. This document has been prepared by Colonial First State Investments Limited ABN 98 002 348 352, AFS Licence 232468 (Colonial First State) based on its understanding of current regulatory requirements and laws as at 6 October 2016. This document is not advice and provides information only. It does not take into account your individual objectives, financial situation or needs. You should read the relevant Product Disclosure Statement available from the product issuer carefully and assess whether the information is appropriate for you and consider talking to a financial adviser before making an investment decision.

Economics overview

• US: If labour market statistics are a fair gauge, the US economy remains in a healthy state. Unemployment fell to 3.9% in April, the lowest level since 2000.
• The latest data showed that inflation (core PCE measure) remained just below 2% in April, at 1.8%.
• Any further inflationary pressure is likely to prompt the Federal Reserve to raise interest rates. The Federal Funds Rate has already been increased once in 2018; most observers are expecting a hike in June and at least one more later in the year.
• Existing home sales have come off the boil, suggesting five interest rate increases in the past 18 months have started to affect the housing market.

• Australia: The 2018-19 Commonwealth Budget was released, but did not contain any major surprises and had no discernible impact on domestic financial markets.
• The 2018-19 budget deficit is expected to be $14.5 billion, or 0.8% of GDP. This was in line with consensus forecasts, but does represent a significant improvement on last year’s position.
• The Government is forecasting a small budget surplus in 2019-20, a year earlier than previously anticipated. This would be a welcome development ahead of the next election.
• Australia’s net debt is expected to peak this year, at 18.6% of GDP. Again, this is earlier than was previously anticipated.
• Shortly after the Budget was released S&P affirmed Australia’s AAA sovereign rating, but also affirmed the negative outlook.
• The Reserve Bank of Australia left interest rates on hold at 1.50%. Futures markets suggest that offshore wobbles in May removed the likelihood of any interest rate increases this year.
• An increase in the participation rate saw the official unemployment rate edge up to 5.6%, from 5.5% previously. This masks reasonably buoyant conditions in the Australian labour market; the economy added 22,600 jobs in April.

• New Zealand: The country’s bi-annual Financial Stability Report suggested lending restrictions first implemented in 2013 have had the desired effect on the housing market. After reaching a high of 15.0% in late 2015, annual house price inflation has fallen sharply. The Reserve Bank of New Zealand will monitor future pricing data to see if and when loan-to-value lending restrictions can be relaxed or withdrawn.
• Unemployment fell to 4.4% in the March quarter, the lowest level since the end of 2008. The buoyant conditions are attracting overseas workers – New Zealand continues to see net migration of around 5,000 people per month.

• Europe: Events in Europe were front and centre of attention in May. Italy’s ongoing difficulty in forming a government and concerns that nationalist parties are attracting increased support prompted suggestions that Italy could review its membership of the European Union and euro single currency.
• These concerns sent shock waves through financial markets globally. Stock markets sold off, bond yields dropped sharply and credit spreads widened.
• Rising energy prices pushed European inflation estimates up to 1.9% yoy in May, the highest level in more than a year. There remains a fair degree of focus on inflation levels, as they may affect the European Central Bank’s stated intention to withdraw its Quantitative Easing program later this year.
• Economic data was mixed. In Germany, for example, factory orders disappointed, but industrial production was ahead of expectations.
• In the UK, the Bank of England downgraded GDP growth and inflation expectations for 2018, 2019 and 2020, but is still entertaining the possibility of further gradual rate rises this year.

• Asia: There was a fair degree of focus on the region in May, mainly due to June’s proposed meeting between US President Trump and Kim Jong Un, the Supreme Leader of North Korea. Trump announced he was withdrawing from the summit, but an official US delegation was nonetheless dispatched to prepare for the meeting, suggesting it may yet go ahead.
• It seems almost certain that there will be many more comments/threats from both sides before North Korea completes a denuclearisation program and/or the US lifts punitive sanctions on the country.
• In economic news, Japanese industrial production in April disappointed, suggesting the economy might be losing steam. The measure of factory output rose 2.5% from a year earlier, but that was well short of expectations for a 3.6% rise.
• Chinese manufacturing activity remained strong. The manufacturing PMI rose to 51.9 in May, exceeding consensus expectations. A strong non-manufacturing PMI print also suggested China’s services sector is performing well.

Australian dollar

• The Australian dollar appreciated by 1.1% against a trade-weighted basket of overseas currencies.
• The ‘Aussie’ added 0.5% against the US dollar.
• Currency markets globally were quite volatile during the month, due to a combination of trade talks/friction between the US and China and political instability in Italy and its effect on the euro.

Commodities

• Commodity prices finished mostly higher, led by industrial metals, coal and oil. Iron ore bucked the trend, declining -1.5% to US$64.3/tonne on concerns surrounding elevated stockpiles.
• Thermal coal prices rose 10.8% in May, reflecting robust demand and declining coal stockpiles at Chinese mines and power plants.
• Brent Crude (+4.6%) rose through most of May, as sidelined OPEC supply continued to drive deficit concerns. In addition, more supply may be involuntarily cut. Investors observed some risk in Venezuela, where oil production collapsed economic and debt crises mount. The US also announced sanctions against Iran, which has the potential to further reduce global supply.
• Industrial metals were mostly higher, led by nickel (+11.5%) which was buoyed by strong demand and falling stockpiles. Lead (+5.4%), aluminium (+1.5%) and copper (+1.1%) also rose, while zinc (-0.9%) and tin (-3.2%) declined.
• Among precious metals, gold fell -1.2% to US$1,300/ounce amid continued strength in the US Dollar.

Australian equities

• The S&P/ASX 200 Accumulation Index added 1.1%, despite an increase in macroeconomic and geopolitical tensions offshore.
• Most sectors delivered positive returns, with Health Care (5.6%) and Consumer Discretionary (5.1%) outperforming.
• The Health Care sector benefited from a strong rally in Mayne Pharma, after it announced that the US Food and Drug Administration had accepted its application for a new drug that will help with the treatment of systemic fungal infections.
• In the Consumer Staples sector, Seven West Media provided an upbeat presentation to the market while rumours of a possible merger between it and Fairfax circulated.
• Telecoms (-10.2%), Consumer Staples (-0.4%) and Financials (-0.2%) were the only sectors to retreat in May.
• Telecoms stocks struggled as sector heavyweight Telstra weighed on sentiment. Telstra declined significantly in the second half of the month after announcing that it expects earnings will be towards the lower end of guidance in FY18 and that it expects challenging trading conditions to persist in FY19 – raising doubts over whether it would be able to fund its dividend.
• Small caps outperformed their large cap counterparts, with the S&P/ASX Small Ordinaries Accumulation Index rising 3.7%. More than two thirds of constituents delivered positive returns.

Listed property

• The S&P/ASX 200 A-REIT Index (TR) had another strong month in May, rising 3.1%.
• Office A-REITs (5.4%) was the best performing sub-sector, while Retail A-REITs (2.8%) was the weakest. Westfield de-listed over May, following approval of its acquisition by Unibail-Rodamco, while the demerged OneMarket (the ex-Westfield technology business) and new Unibail CDIs began to trade on the ASX.
• The strongest performers were Investa Office Fund (15.0%), Vicinity Centres (9.4%), and Charter Hall Group (8.0%). Investa Office Fund received an all-cash takeover offer from Blackstone at $5.25, which the board will recommend to shareholders in the absence of a superior proposal.
• The weakest performers were Iron Mountain (-3.2%), National Storage REIT (-0.9%), and Cromwell Property Group (0.0%).
• Globally, major property market returns again outperformed broader equity markets. The FTSE EPRA/NAREIT Developed Index (TR) rose 1.7% in USD terms. In local currency terms, the US (4.8%) was the best performing market, while Singapore (-4.4%) was the worst.

Global equities

• Global equity markets broadly ended the month in the black. The MSCI World limped to a return of 0.7% (in USD terms) having been up as much as 2.6% mid month. This benign outcome hides some relatively disparate returns across and within markets. IT stocks powered the US bourse, which was the strongest performer among major developed markets and drove a wedge between growth and value stocks.
• The S&P 500 finished up 2.4% in local currency, having been up as much as 3.4%. Apple drove the IT sector markedly higher, reaching a record high during the month. The smartphone manufacturer reported strong sales, a robust outlook and dispelled April’s fears over weaker iPhone sales. The US energy sector also had a solid month as oil prices rallied.
• The Japanese Nikkei, down -1.7% in local currency terms, was the weakest of the major markets. Geopolitical uncertainty on the Korean peninsula, disappointing factory output and a possible global trade war contributed to market weakness.
• Value stocks suffered their worst month against growth stocks since the ‘green shoots recovery’ began in February 2009. The MSCI World Value Index fell -1.2% in USD terms, while the MSCI World Growth Index added 2.6%, helped by IT stocks.
• Emerging Markets also underperformed, down -3.5% in USD terms. Latin America was pulled down by both Brazil, (-16.4% in USD) and Mexico (-13.6% in USD). Both countries face the prospect of higher interest rates as central banks seek to defend their currencies against higher US rates and a stronger US dollar.

Global and Australian Fixed Interest

• May was a month of two halves for global bond markets.
• Yields moved steadily higher early in the month. 10-year US Treasury yields rose through 3%, then 3.05%, then 3.10%. Trade concerns were abating, with the US delaying the implementation of tariffs on steel imports from Europe, Canada and Mexico. With yields rising, breaking out of long term trading ranges and with the oil price appreciating, investors suggested we could finally be about to see a significant and sustainable move higher in yields globally. Then, in just a few sessions, sentiment was turned on its head as events in Italy started to unravel.
• The catalyst for global markets to go into a tailspin in mid-May was a coalition seemingly formed with parties that had campaigned against European Union policies or even Italy’s ongoing membership of the Union.
• Risk appetite nosedived as it emerged that a second election – possibly sometime in the next few months – could see populist parties attract increased support and potentially win power. Bond yields dropped sharply as investors absorbed the news flow.
• Events in May saw 10-year US Treasury yields fall 9 bps, to 2.86%. Japanese 10-year JGB yields declined 2 bps, to 0.03%. In the UK, 10-year gilt yields closed 19 bps lower, at 1.23%.

Global credit

• Like other risk assets, sentiment towards corporate bonds was affected by uncertainty in Italy and the flow-on effects on risk appetite more broadly. Global investment grade credit spreads widened by 13 bps, to 1.18%.
• The ‘risk off’ backdrop was also reflected in the US high yield market, where spreads widened 22 bps, to 3.17%.
• Issuance slowed in the second half of the month, in particular. With deteriorating risk appetite pushing spreads wider, corporates appeared to hold off issuing until markets calmed.
• While Italy-related concern had abated by month end, sentiment towards credit remained fragile. Investors remain wary of trade tensions and the potential impact protectionist policies could have on corporate profitability in the US, in particular.

Chart of the Month – Responding to the insatiable appetite for infrastructure
In these bulletins, we aim to share interesting observations from global investment markets. This month we look at the ever increasing appetite for unlisted infrastructure and how investors are responding to any resulting valuation pressures.

Unlisted infrastructure has great appeal to certain investors. The fact that it is illiquid and traded infrequently brings two immediate benefits – its returns have low correlations with listed investments over the short term and there is an illiquidity premium that investors can enjoy if they can afford to have assets locked up for up to 10 years or more. This is an ideal outcome for the large institutional investors that enjoy net cash inflows and have long-term liabilities that need matching.

However, there are signs that the sector might be over-loved. As these larger investors have sought to access the diversification benefits and illiquidity premia, combined with the steady income associated with infrastructure projects, the asset class has grown rapidly over the last decade. As shown in the chart, assets under management (AUM) held by unlisted infrastructure fund managers has quadrupled over this period – from US$99bn in 2007 to US$421bn in 2017.

The expansion of the industry has brought with it noticeable challenges – the amount of capital held by managers has also been rising, with dry powder levels hitting a record high of US$152bn last year. The increased amounts “waiting on the sideline” to be invested has increased competition for new investments and rising valuations. According to Preqin’s research “Valuations have yet again emerged as the number one concern among fund managers in our survey”. Preqin has also reported, however, that unlisted infrastructure fund managers have been deploying their dry powder ever more quickly since 2013 – the ratio of ‘Year End Unlisted Infrastructure Dry Powder’ to ‘Prior Year Capital Called’ was at 2.5 years at the end of 2016 compared to 3.8 years in 2013.

What are the implications for investors? Our Unlisted Infrastructure team has responded to increased competition for deals by sourcing assets in better valued pockets of the market, such as smaller and bolt on deals rather than chasing elephants / trophies in the large cap space. By adopting this approach, they have been able to deploy capital quicker than the market as a whole (last year their Dry Powder to Prior Year Capital Called was less than a year – well below the broader industry). Along with our Global Listed Infrastructure team, they also point to the enormous investment needed globally with the traditional public providers of infrastructure challenged by deteriorating fiscal positions and, therefore, less equipped to fund the estimated US$57+ trillion of investment required to keep GDP at current levels. This suggests that demand will be more than sufficient to soak up the current (and growing) supply.

Required global investment 2013-2030 US$trillion, Constant 2010 dollars. Source: McKinsey & Co.

 

Want more information?
Please speak with your financial adviser Mark Giles Mark Giles of Complete Financial Solutions (WA) – Financial Planning (ABN26 050 157 938) is an authorised representative of Financial Wisdom Limited (ABN) 70 006 646 108 AFSL 231138). Alternatively visit our website at completefinsol.com.au or contact Colonial First State Investments Limited at colonialfirststate.com.au or phone 13 13 36. © Colonial First State Investments Limited ABN 98 002 348 352 AFS Licence 232468. This document has been prepared by Colonial First State Investments Limited ABN 98 002 348 352, AFS Licence 232468 (Colonial First State) based on its understanding of current regulatory requirements and laws as at 6 October 2016. This document is not advice and provides information only. It does not take into account your individual objectives, financial situation or needs. You should read the relevant Product Disclosure Statement available from the product issuer carefully and assess whether the information is appropriate for you and consider talking to a financial adviser before making an investment decision.

Disclaimer
This document is directed at persons of a professional, sophisticated or wholesale nature and not the retail market.

This document has been prepared for general information purposes only and is intended to provide a summary of the subject matter covered. It does not purport to be comprehensive or to give advice. The views expressed are the views of the writer at the time of issue and may change over time. This is not an offer document, and does not constitute an offer, invitation, investment recommendation or inducement to distribute or purchase securities, shares, units or other interests or to enter into an investment agreement. No person should rely on the content and/or act on the basis of any matter contained in this document.

This document is confidential and must not be copied, reproduced, circulated or transmitted, in whole or in part, and in any form or by any means without our prior written consent. The information contained within this document has been obtained from sources that we believe to be reliable and accurate at the time of issue but no representation or warranty, express or implied, is made as to the fairness, accuracy or completeness of the information. We do not accept any liability for any loss arising whether directly or indirectly from any use of this document.

References to “we” or “us” are references to Colonial First State Global Asset Management (CFSGAM) which is the consolidated asset management division of the Commonwealth Bank of Australia ABN 48 123 123 124. CFSGAM includes a number of entities in different jurisdictions, operating in Australia as CFSGAM and as First State Investments (FSI) elsewhere.

Past performance is not a reliable indicator of future performance.

Reference to specific securities (if any) is included for the purpose of illustration only and should not be construed as a recommendation to buy or sell. Reference to the names of any company is merely to explain the investment strategy and should not be construed as investment advice or a recommendation to invest in any of those companies.

In Australia, this document is issued by Colonial First State Asset Management (Australia) Limited AFSL 289017 ABN 89 114 194311.

Copyright © Colonial First State Group Limited 2018

All rights reserved

Economics overview

• US: Following a period where market sentiment was largely driven by geopolitical news flow and events, investors started to refocus on the outlook for growth and monetary policy globally. This was the primary driver of bond yields over the month.
• Equity investors focused on a favourable Q1 earnings reporting season in the US. In April, around half of S&P 500 companies announced their results for the first three months of 2018. Of these, more than three quarters beat consensus expectations and have reported earnings growth of 24.6%, more than double that expected according to Thomson Reuters.
• Data confirmed the US economy grew by 2.3% in the 12 months to 31 March 2018. This was a slowdown from the 2.9% yoy growth in the previous quarter, mainly attributable to more subdued consumer spending versus the hurricane-related replenishment spree of the previous quarter.
• Few observers seemed concerned about the slowdown, in the belief that consumer spending and growth will reaccelerate next quarter driven by tax cuts and the solid employment market.
• Unemployment in the US remained at a 17-year low of 4.1% in March 2018, where it has been for the past six months.
• There was a modest increase in US price pressures, with the core inflation measure most closely watched by policy makers – picking up to 1.9% yoy in March, the fastest pace in more than a year and approaching the Federal Reserve’s 2.0% target.
• This supports the case for further increases in interest rates in the remainder of 2018 and beyond. Global markets continue to pay close attention to commentary released by Federal Reserve Board members regarding monetary policy.

• Australia: As anticipated, the Reserve Bank of Australia (RBA) left domestic interest rates on hold a 1.50%. Official borrowing costs have been at this level since August 2016 – the longest period that Australian interest rates have remained unchanged.
• CPI data confirmed that inflation ran at an annual pace of 1.9% in the March quarter; in line with the final quarter of 2017. With inflation under control, there appears to be a low probability of the RBA increasing interest rates in the near future.
• Employment growth appears to be coming off the boil. Just 4,900 jobs were added in March, well below the +20,000 forecast. Unemployment remains steady at 5.5%. Owing to net migration into Australia and the associated increase in the workforce, strong job growth over the past year or so has not had a significant impact on the official unemployment rate.
• Helped by solid bulk commodity exports – primarily coal and iron ore – Australia continues to enjoy a healthy trade surplus. Exports were $825 million greater than imports in February.

• New Zealand: Inflation fell to an 18-month low of 1.1% yoy in the March quarter. Lower education costs appeared to contribute, with the government having made the first year of tertiary education free to students.
• House construction prices rose 0.4%, the smallest since 2011.
• With inflation towards the lower end of the RBNZ’s 1% to 3% target range, few observers are expecting interest rates to be increased from the current 1.75% level this year.

• Europe: European growth appears to have moderated in early 2018. French GDP growth decelerated in the March quarter.
• The European Central Bank has suggested any moderation in the pace of growth will prove temporary and that conditions remain supportive of a broad-based expansion.
• Economies in the EU continue to benefit from zero interest rates and an ongoing QE program. The latter is due to conclude later this year, but could be extended if required.
• UK GDP growth has also slowed from 2017. The economy expanded at an annual pace of 1.2% in the March quarter, below forecasts and the slowest pace in more than five years.
• UK inflation has also decelerated, to 2.5% yoy. This suggests the Bank of England might not need to amend policy settings – the previously anticipated interest rate hike in May now appears to be a possibility rather than a probability.

• Asia: Moderating food prices have fed through to lower overall inflation in Japan. Prices rose just 1.1% yoy to March 2018.
• The Bank of Japan is believed to be considering when and how best to remove its current QE program. The lower inflation reading suggests there may be no pressing need to do so.
• For now, official Japanese interest remain negative, at -0.10%
• In China, data showed the economy grew at an annual pace of 6.8% in the March quarter. The government continues to target 6.5% yoy economic expansion as the economy transitions towards domestic growth from export-oriented growth.
• In South Korea, the economy grew at an annual pace of 2.8% in the March quarter. April saw a historic meeting between the leaders of North and South Korea, with the two Heads of State agreeing to end the 65-year long Korean War and to complete a full denuclearisation of the Korean Peninsula.

Australian dollar

• The subdued inflation print – combined with stronger data in the US – saw the Australian dollar weaken nearly 2% against the US dollar. The Australian dollar fell by less against a trade-weighted basket of currencies, declining by just 0.3%.

Commodities

• Commodity prices were mixed in April, against a background of geopolitical uncertainty. Aluminium (+11.4%) was the standout performer after the US imposed sanctions on Russian aluminium giant Rusal. Nickel (+3.6%) and Copper (+1.1%) posted smaller gains, while Lead (-2.7%) and Zinc (-4.8%) declined. Coking coal had another poor month, falling -13.4%.
• WTI Crude continued its upward momentum, adding 5.6% to US$68.57 per barrel. Robust demand, coupled with sidelined supply and trade sanctions helped support prices.
• After sharp falls last month – on surplus concerns in China’s steel market – iron ore prices steadied, edging 0.7% higher to US$65.30 per tonne.
• Gold fell -0.5% to US$1,315 per ounce on the back of a strengthening US dollar.

Australian equities

• The S&P/ASX 200 Accumulation Index rose 3.9%, benefiting from heightened takeover activity. All sectors posted positive returns with Energy (+10.8%), Materials (+7.6%) and Health Care (+7.4%) the best performers.
• Energy and Materials stocks rallied reflecting rising commodity prices. Santos benefited further from the receipt of a takeover proposal from Harbour Energy, which valued Santos at A$6.50, more than a 28% premium to the previous close.
• Similarly, the Health Care sector benefited from a strong performance from Healthscope after it received a bid from a consortium of financial investors for an indicative price of A$2.36, representing a 16% premium to the previous close.
• In the Utilities sector (+2.3%), Infigen Energy delivered the largest return as Brookfield Asset Management’s sudden purchase of a substantial holding sparked takeover speculation.
• The Financials sector (+0.2%) delivered the lowest return in April as several acts of market misconduct were brought to light through the Royal Commission.

Global equities

• The MSCI World Index recovered from trade dispute induced intra-month lows of -1.4% (in USD terms) as investors started to focus instead on an encouraging earnings season in the US. The index was up as much as 2.9%, before reports that global smartphone sales might have peaked saw technology stocks tumble. The broader index recovered to finish April up 1.2%.
• Despite delivering more than double the earnings growth expectations, the S&P 500 Index was one of the weaker markets. Some investors are now questioning whether earnings growth can improve any further, particularly with a further three US interest rate increases anticipated for this year. The UK FTSE 100 Index was one of the stronger markets, as a depreciating pound propelled the UK bourse to its highest level in almost three months. The Index finished up an impressive 6.8% in local currency terms.
• Value stocks edged ahead of their growth counterparts in April. Large cap stocks also outperformed small caps, with a rallying energy sector helping to offset the hit to large cap US technology stocks mid-month.
• The deteriorating outlook for smartphone sales also contributed to the MSCI Emerging Markets falling -0.4% in USD terms.
• Taiwan Semiconductors, one of Apple’s largest suppliers for iPhone manufacture, fell almost -10% after warning shareholders of “weak demand” from the mobile phone sector.
• In fact Taiwan was one of the weakest markets, down -4.6% in USD terms. Russian stocks also struggled, down -7.4% as sanctions and diplomatic tensions over the recent spy poisoning in the UK triggered a run on Russian-related assets.

Listed property

• The S&P/ASX 200 A-REIT Index performed strongly in April, returning 4.5%. Industrials (+7.6%) was again the best performing sub-sector. Retail A-REITs (+5.2%) turned around their recent run of underperformance to be the next strongest, while Office A-REITs (+1.8%) lagged.
• A-REITs performed well despite significant increases in bond yields in both the US and Australia.
• The strongest individual performers were Westfield (+8.0%), Goodman Group (+7.6%), and Iron Mountain (+6.5%). Westfield shareholders are scheduled to vote on the proposed takeover by Unibail-Rodamco in late May, and with no competing bidders, the deal is expected to be completed in June.
• The weakest performers were Viva Energy REIT (+1.0%), Vicinity Centres (+1.2%), and Dexus (+1.8%).
• Viva Energy REIT underperformed despite a lack of company-specific news, while Vicinity Centres struggled on concerns over soft retail sales metrics.
• Overseas property market returns were solid too and again outperformed broader equity markets. The FTSE EPRA/NAREIT Developed Index returned 2.0% in USD terms. In local currency terms, Japan (+5.5%) was the best performing market, while the US (+1.3%) was the worst.

Global and Australian Fixed Interest

• Sovereign bond yields continued to trade in reasonably wide ranges during April. Overall market volatility dissipated a little from the elevated levels seen in February and March, but investors then refocused on fundamental drivers of fixed income markets (such as higher US official interest rates). During February and March, in particular, there had been a greater focus on geopolitical developments and risks.
• Following a reversal over that period, yields resumed their uptrend in April supported by generally favourable economic conditions in the US.
• Treasury yields rose as investors digested the modest increase in US CPI data releases. The likelihood of future interest rate hikes increased accordingly.
• Monetary policy expectations did not rise as significantly in other markets. 10-year government bond yields rose 7 bps and 6 bps in the UK and Germany respectively, and by 1 bp in Japan.
• Australian yields increased consistent with offshore moves, reversing some of the declines seen in March. The 10-year Australian bond yield closed the month at 2.77%, an increase of 17 bps from the end-March level. The curve steepened as longer-dated yields were pushed significantly higher.

Global credit

• Spreads were little changed, meaning government bond yields were the main driver of corporate bond returns over the month.
• Improving profitability from the US earnings season to date supports issuers’ ability to service their repayment obligations and should continue to support a low level of defaults globally.
• Many corporates remain highly leveraged, potentially causing some concern as funding costs increase.
• A number of US issuers appear to be considering M&A, deploying excess capital being repatriated to the US under the revised corporate taxation regime. Some have also noted increasing cost pressures, particularly relating to rising energy prices. Strong corporate profitability and low unemployment have not yet been reflected in significantly higher wages.

Operating in a populated market, the a2 Milk Company (A2M) has experienced exceptional success with its differentiated product offering. Since listing on the Australian Securities Exchange on the 31st of March 2015, A2M’s share price has risen over 1900% (as of 30th April 2018). The company’s marketing slogan of ‘feel the difference’, as well as the ‘clean and green’ perception of Australia and New Zealand, have been key contributors to the company’s success. Today, A2M holds a 9% share of the fresh milk market and >30% share of the infant formula market in Australia.

However some investors are, understandably, starting to question whether A2M’s share price is now overvalued given its substantial rally. In response, our Australian Equities Growth team argues that continued market share gains in infant formula sales in China, both via cross-border channels and MBS (Mother & Baby Stores) is going to continue to be a primary driver of profit growth going forward. They also believe that the recently announced partnership with Fonterra will help drive the company’s plan to expand further into South East Asia and the Middle East. While competitors such as Nestle have announced their intention to expand into A2 only products, this highlights the major impact A2M has had on the global market. The growing acceptance of the health benefits associated with A2-only dairy products will, in the opinion of our Australian Equities, Growth team, likely increase A2M’s exposure. A2M’s expected product expansion into adult nutrition and other dairy products would provide yet another avenue of growth for the company and may well be the beginning of a new global trend in dairy consumption.

Our Australian Equities, Growth team do not believe that these next waves of growth are being fully reflected in the share price and continue to hold the stock.

Source: Factset, to 30 April 2018

Want more information?

Please speak with your financial adviser Mark Giles Mark Giles of Complete Financial Solutions (WA) – Financial Planning (ABN26 050 157 938) is an authorised representative of Financial Wisdom Limited (ABN) 70 006 646 108 AFSL 231138). Alternatively visit our website at completefinsol.com.au or contact Colonial First State Investments Limited at colonialfirststate.com.au or phone 13 13 36. © Colonial First State Investments Limited ABN 98 002 348 352 AFS Licence 232468. This document has been prepared by Colonial First State Investments Limited ABN 98 002 348 352, AFS Licence 232468 (Colonial First State) based on its understanding of current regulatory requirements and laws as at 6 October 2016. This document is not advice and provides information only. It does not take into account your individual objectives, financial situation or needs. You should read the relevant Product Disclosure Statement available from the product issuer carefully and assess whether the information is appropriate for you and consider talking to a financial adviser before making an investment decision.

Disclaimer
This document is directed at persons of a professional, sophisticated or wholesale nature and not the retail market.

This document has been prepared for general information purposes only and is intended to provide a summary of the subject matter covered. It
does not purport to be comprehensive or to give advice. The views expressed are the views of the writer at the time of issue and may change
over time. This is not an offer document, and does not constitute an offer, invitation, investment recommendation or inducement to distribute or
purchase securities, shares, units or other interests or to enter into an investment agreement. No person should rely on the content and/or act on
the basis of any matter contained in this document.

This document is confidential and must not be copied, reproduced, circulated or transmitted, in whole or in part, and in any form or by any means
without our prior written consent. The information contained within this document has been obtained from sources that we believe to be reliable
and accurate at the time of issue but no representation or warranty, express or implied, is made as to the fairness, accuracy or completeness of
the information. We do not accept any liability for any loss arising whether directly or indirectly from any use of this document.

References to “we” or “us” are references to Colonial First State Global Asset Management (CFSGAM) which is the consolidated asset
management division of the Commonwealth Bank of Australia ABN 48 123 123 124. CFSGAM includes a number of entities in different
jurisdictions, operating in Australia as CFSGAM and as First State Investments (FSI) elsewhere.

Past performance is not a reliable indicator of future performance.

Reference to specific securities (if any) is included for the purpose of illustration only and should not be construed as a recommendation to buy or
sell. Reference to the names of any company is merely to explain the investment strategy and should not be construed as investment advice or a
recommendation to invest in any of those companies.

In Australia, this document is issued by Colonial First State Asset Management (Australia) Limited AFSL 289017 ABN 89 114 194311.

Copyright © Colonial First State Group Limited 2018

All rights reserved

Economics overview

• US: As expected, the Federal Reserve raised the target range for the federal funds rate by 25 basis points, to 1.5%-1.75%. At least two further interest rate hikes in the US are anticipated in the remainder of 2018.
• More importantly, interest rate forecasts for 2019 and 2020 were increased in light of the strengthening economic growth outlook.
• Q4 2017 GDP growth data was revised upwards, to 2.9% yoy.
• Growth forecasts were also upgraded to 2.7% yoy for 2018 (from 2.5%) and to 2.4% yoy for 2019 (from 2.1%). The improved outlook is being supported by a firmer labour market.
• In other news, President Trump announced proposed new tariffs on around 1,300 products imported from China. Steel and aluminium, for example, will have tariffs of 25% and 10% applied, respectively. The moves are designed to reduce the price competitiveness of imports and, in turn, help protect US industries. The US administration is also trying to reduce the trade deficit with China, which reached ~US$375 billion in 2017.
• US imports from other countries – including Australia and EU countries – are unaffected for now, although talks are continuing and future tariffs remain a possibility.

• Australia: The Reserve Bank of Australia (RBA) left interest rates unchanged, at 1.5%.
•  In the statement that followed the interest rate announcement, the RBA noted that higher commodity prices and tight labour markets are likely to see inflation pick up in the next two years. For now, Australian inflation remains low, with both CPI and underlying inflation running below 2.0%.
• The RBA also expects the domestic economy to grow faster in 2018 than it did in 2017, supported by buoyant business spending and public infrastructure investment.
• The latest statistics indicated an increase in unemployment, to 5.6%. We note, however, that this series has been a little volatile recently and do not believe a clear trend is in place.

• New Zealand: Running at an annual pace of 1.6%, inflation in New Zealand appears to remain under control.
• In its latest policy statement, however, the Reserve Bank of New Zealand suggested that inflationary pressures are starting to build owing to rising commodity and agricultural prices.
• An increase in CPI could prompt the Bank to consider raising interest rates. Policy was last amended in November 2016, when interest rates were lowered to a record low of 1.75%.
• Data showed that New Zealand had a trade surplus in February, with exports NZ$217 million ahead of imports. Food and lumber sales to China were particularly strong.

• Europe: Attention shifted towards EU growth rates in the March quarter, with the Bundesbank suggesting that the German economy continues to perform well. German factory orders appear to remain buoyant and household demand is being supported by rising wages and employment.
• For now, the Eurozone refinancing rate remains at 0.0% and the European Central Bank’s $30 billion/month QE program continues.
• In the UK, there was a significant moderation in inflation, with CPI falling to 2.7% (from 3.0%). This was the lowest inflation reading for seven months.
• UK unemployment declined to 4.3%, the lowest level since 1975. Wage growth was above expectations, providing further encouragement.
• The Bank of England left UK interest rates unchanged at 0.5%, but reiterated that tighter monetary will be required to keep inflation under control and close to the 2.0% target.
• Accordingly, markets priced in an increased likelihood of a rate hike as early as May 2018. Two of the nine-member Monetary Policy Committee have already called for a rate hike.

• Asia: China responded to President Trump’s proposed import tariffs on Chinese goods by imposing tariffs of its own on products imported from the US.
• A ‘trade war’ is unlikely to appeal to either country, suggesting there is scope for negotiation before the proposals are implemented.
•  Meanwhile, Chinese inflation rose to 2.9% yoy, its highest level since 2013. This was primarily due to an increase in food prices.
•  Japanese inflation also picked up to 1.5% yoy, the highest level in nearly three years. In spite of the increase monetary policy was unchanged, with negative interest rates (-0.1%) and an ongoing ¥60 billion/month QE program.
• The Japanese labour market has been improving markedly. The unemployment rate dropped to 2.4% in January; a 25-year low.

Australian dollar

• The Australian dollar declined -2.0% against a trade-weighted basket of currencies.
• A stronger US dollar, lower commodity prices and rising global trade tensions weighed on the AUD/USD cross and contributed to Australian dollar underperformance relative to other major currencies.
•  The moderating Australian interest rate outlook also did little to support sentiment.

Commodities

• Most commodity prices declined, as escalating trade tensions between the US and China created market uncertainty.
• Iron ore (-18.7%) and coking coal (-16.9%) prices fell sharply, reflecting surplus concerns in the Chinese steel market. The build-up in Chinese steel stockpiles was partly the result of an unexpected increase in China’s steel output during January and February. Markets were also concerned that a slowing property sector in China could curb demand.
• Thermal coal prices fell -13.6%, as recent shortage concerns eased. Chinese policymakers have looked to boost thermal coal imports and domestic supply, particularly in response to high prices and rising demand from the coal-fired power sector.
• Oil prices bucked the downward trend, rising 5.7% in March, as OPEC and its allies continued their program to restrict supply.
• Base metals were broadly lower, with Aluminium (-7.5%), Copper (-3.9%), Zinc (-4.8%) and Lead (-4.7%) all declining.
• Gold prices edged 0.6% higher, in line with a slightly weaker US dollar, and as the prospect of a trade conflict prompted ‘safe haven’ demand.

Australian equities

• The Australian equity market delivered another lacklustre performance in March, with the S&P/ASX 200 Accumulation Index declining -3.8%.
• Bond proxy sectors, such as Real Estate and Utilities, were the best pest performers, only falling -0.2% and -0.8% respectively.
• For the second month in a row, Telecoms (-6.1%) was the worst performing sector. Telstra (-6.3%), TPG Telecom (-10.1%) and Vocus Group (-9.4%) dragged the sector down.
• Financials (-5.8%) struggled, with the ongoing banking Royal Commission increasing investor concerns. Several regional banks including Bank of Queensland (-13.2%) and Bendigo & Adelaide Bank (-10.4%) helped drag the sector lower, along with Perpetual (-10.3%) and Insurance Australia Group (-8.8%).
• The Materials sector fell -4.3%, with the majority of constituents generating negative returns. Heavyweights BHP Billiton (-5.2%) and Rio Tinto (-7.8%) both weighed significantly on performance as commodity prices declined through the month.
• Energy (-2.5%) also declined, despite rising oil and gas prices.

Listed property

• The S&P/ASX 200 A-REIT Index was little changed, returning 0.1%. Industrial A-REITs (2.7%) was again the best performing sub-sector. Office A-REITs (1.4%) also performed well, while Retail A-REITs (-1.2%) continued their underperformance from February to again be the weakest sub-sector. A-REIT performance was supported by falling Australian bond yields.
• The strongest performers were Iron Mountain (7.3%), Cromwell Group (6.5%), and Shopping Centres Australasia (4.0%). Iron Mountain continued its strategy of expanding into new geographies and businesses, with the acquisition of US art transportation company Artex Fine Arts Services.
•  The weakest performers were Vicinity Centres (-2.8%), Westfield (-2.7%), and Charter Hall Group (-2.1%). Vicinity continues to be hurt by deteriorating sales metrics and structural and cyclical headwinds in the retail sector, while Westfield faces some lingering uncertainty around the Unibail takeover.
• Global property market returns were relatively strong, against a weak broader market. The FTSE EPRA/NAREIT Developed Index returned 2.5% in USD terms. In local currency terms, the UK (4.3%) was the best performer, while Hong Kong (-2.5%) was the worst.

Global equities

• Fears of a trade war between the US and China and speculation that the Trump administration is considering a crackdown on Chinese investments in the technology sector weighed on global equity markets. The MSCI World Index ended the month -2.1% lower in USD terms, completing the poorest March quarter return since the end of the GFC.
•  Japanese stocks struggled (-2.7%). The yen rose to a 16-month high and fallout from the cronyism scandal undermined confidence in Prime Minister Abe’s Government.
•  The German DAX Index was one of the better performers, but was still down -1.9%. The German Social Democrats (SPD) endorsed their party leadership’s decision to renew the Grand Coalition and delivered greater political stability.
•  Emerging markets fell -1.8%. The MSCI EM Latin America Index was the strongest performer of the regional benchmarks (-0.9% in USD terms). Mexico performed relatively well (+0.8% in USD terms); the peso and stocks rallied on US President Trump’s decision to exempt Mexico and Canada from new steel and aluminium tariffs. MSCI EMEA (-4.9%) lagged, with Greece down -9.9% in USD terms as its banks increased provisions for bad loans.

Global and Australian Fixed Interest

• Bond markets rallied, with generic 10-year government bond yields falling 12 bps in the US, 15 bps and 16 bps in the UK and Germany respectively, and 21 bps in Australia. Yields traded in unusually wide ranges (>20 bps) in most major bond markets
•  LIBOR (the rate used to calculate interest payable on short-term loans that banks make to one another) increased in the US. Arguably the more interesting moveis the spread between LIBOR and Overnight Indexed Swap rates; commonly referred to as the ‘TED’ spread. In the US, 3-month TED spreads increased to their widest level since 2009. We examine the Australian equivalent spread in our ‘Chart of the Month’ on the following page.
• Australian government bonds continued to outperform US Treasuries, with the 10-yr yield differential declining to -14bps.
•  Interestingly, the correlation between equity and bond markets continued to fall. During March, sessions where global equity markets sold off aggressively typically saw limited movement in bond yields. It will be interesting to see whether the historic correlation reasserts itself in the June quarter and beyond, or whether bonds and equities will continue to be driven by their own unique factors.

Global credit

• Credit spreads widened given rising short-term funding costs for corporates and associated equity market weakness.
• Investors’ lower risk appetite was most clearly reflected in the US high yield market, where spreads widened significantly.
• As well as rising funding costs, short-term technical factors have been unsupportive of global credit. Significant issuance in early 2018 resulted in a sharp increase in supply, which coincided with a period of moderating demand. We have seen outflows from credit markets in Europe, for example, and Asian buyers appear to have stepped back from the market in recent weeks.
• In other news, the Q4 earnings reporting season in the US concluded with the last few remaining companies releasing their results. On the whole, earnings were in line with – or, in some cases, marginally above – consensus expectations and outlook statements highlighted general optimism. The financial implications of US corporate tax changes appear to have fully filtered through to consensus expectations and no longer appear to be an important driver of valuations.

In these bulletins, we aim to share interesting observations from global investment markets.

This month we examine the recent significant widening in spreads between BBSW (the rate used to calculate interest payable on short-term loans that Australian banks make to one another) and domestic cash rates. The 3-month spread blew out by more than 20 basis points in March alone, rising above 0.50%. This was the widest level since 2011.

Source: Bloomberg, to 31 March 2018

Rather than being an Australia-centric move, the rise in funding costs has been a global phenomenon. The key question for investors is whether the global moves are indicative of pressure in credit markets and bank funding. These concerns follow experience from mid-2007, when spreads widened significantly prior to the GFC the following year.

We do not believe the recent moves are credit-driven, but do acknowledge there is some risk that tighter funding conditions spill over and impact the Australian credit market more broadly. This is a risk that we are monitoring closely.

For now, it appears that the global moves are more technically driven. Some of the apparent drivers include the following:

• Ongoing monetary policy tightening by the US Federal Reserve – both higher cash rates and the unwinding of Quantitative Easing measures.
• Significant recent issuance of short-dated Treasuries after the US debt ceiling was raised in February 2018, to fund corporate tax cuts and higher government spending.
• Corporate bond sales in preparation for the US dollar repatriation of cash, following changes to the US corporation tax regime.
• Recent increase in longer-term Treasury yields, causing investors to move along the curve in pursuit of longer duration and higher carry.
• Investors rebalancing their equity exposure following the recent sell-off in share markets.

These drivers appear unlikely to go away in the foreseeable future, suggesting the spread could remain higher than average for the foreseeable future.

It is worth noting that higher cash and BBSW rates are likely to support performance in portfolios indexed to bank bills or BBSW, as their total returns should benefit from movements in the short end of the yield curve.

Disclaimer
This document is directed at persons of a professional, sophisticated or wholesale nature and not the retail market.

This document has been prepared for general information purposes only and is intended to provide a summary of the subject matter covered. It does not purport to be comprehensive or to give advice. The views expressed are the views of the writer at the time of issue and may change over time. This is not an offer document, and does not constitute an offer, invitation, investment recommendation or inducement to distribute or purchase securities, shares, units or other interests or to enter into an investment agreement. No person should rely on the content and/or act on the basis of any matter contained in this document.

This document is confidential and must not be copied, reproduced, circulated or transmitted, in whole or in part, and in any form or by any means
without our prior written consent. The information contained within this document has been obtained from sources that we believe to be reliable
and accurate at the time of issue but no representation or warranty, express or implied, is made as to the fairness, accuracy or completeness of
the information. We do not accept any liability for any loss arising whether directly or indirectly from any use of this document.

References to “we” or “us” are references to Colonial First State Global Asset Management (CFSGAM) which is the consolidated asset
management division of the Commonwealth Bank of Australia ABN 48 123 123 124. CFSGAM includes a number of entities in different
jurisdictions, operating in Australia as CFSGAM and as First State Investments (FSI) elsewhere.

Past performance is not a reliable indicator of future performance.

Reference to specific securities (if any) is included for the purpose of illustration only and should not be construed as a recommendation to buy or
sell. Reference to the names of any company is merely to explain the investment strategy and should not be construed as investment advice or a
recommendation to invest in any of those companies.

In Australia, this document is issued by Colonial First State Asset Management (Australia) Limited AFSL 289017 ABN 89 114 194311.

Copyright © Colonial First State Group Limited 2018

All rights reserved