By Matthew J. Arnold, CFA, Head of Strategy & Research – APAC, SPDR ETFs
State Street Global Advisers
Following US President Donald Trump’s election in November last year, investors rotated out of fixed income and into asset classes that tend to do well during periods of economic expansion, such as the shares of cyclically oriented companies. The prevailing market view was that Trump, supported by a Republican-controlled Congress, would be able to institute a raft of business-friendly measures, such as tax cuts, increased infrastructure investment and a scaling back of regulations. Against this backdrop, investors thought that the recovering global economy would get something of a ‘shot in the arm’ that would ultimately result in higher corporate earnings growth and higher interest rates. The earnings picture did improve in most major markets, but the Trump administration has yet to implement much in the way of new policy. Outside of the US, investors have remained focused on the political landscape in Europe, where the French and Dutch elections and the ongoing Brexit negotiations remained on centre stage. The favourable election results, at least from the
perspective of those that support a united Europe, contributed to further improvements in investor sentiment already buoyed by signs of stronger economic and corporate earnings momentum. Emerging markets assets have also recovered strongly year-to-date. Sold off after the US election, emerging markets equity and bond ETFs have experienced significant inflows due to the favourable relative valuations and higher bond yields. The threat of a US-led ‘trade war,’ which contributed to the postelection sell-off in emerging market currencies, has also receded for the time being. After a slow start to the year, flows into Australian ETFs have picked up significantly in recent months. Total industry assets are now approaching A$28 billion, while inflows as at 30 April 2017 have exceeded A$1.4 billion.1 Australian equity ETFs have proved to be most popular with inflows of more than A$260 million as of 30 April 2017.2 International exposures and fixed interest ETFs have also been popular with local investors.
INTERNATIONAL EQUITIES OUTPERFORM
Led By Technology
The global ‘reflation trade’ led by Financials and cyclical sectors such as Materials and Industrials, which began to emerge in the latter half of 2016 and picked up speed after the US election, has stalled somewhat, although equities have continued to advance. So far in 2017, we have witnessed a change in market leadership: Technology and more traditionally defensive sectors such as Consumer Staples, Utilities and Health Care have led the market year-to-date. The strength of technology stocks, particular bellwethers like Facebook and Apple in the US has contributed to the outperformance of international over local equities so far this year. The Australian market, dominated by Banks and Resources stocks, has returned 2.9%, while international equities (unhedged) have gained 7.7%. As noted earlier, investor sentiment towards emerging markets assets has improved this year, which contributed to a gain of 13.4% in the broad S&P Emerging Markets index3. The strength of international equities once again highlights the benefits of adopting a diversified approach to investing. And with SPDR ETFs, this can be achieved in a diversified a low-cost way.
FINANCIALS TAKE A BREATHER
Australian financials stocks, like their counterparts elsewhere, have underperformed year-to-date, due in part to the pattern of flattening yield curves in key government bond markets. Bank earnings in particular are very sensitive to changes in interest rates, and they generally perform better during periods when the yield curve is steepening (i.e. longer term rates are moving higher). Some investors have also clearly been concerned that Australian banks are overexposed to the increasingly ‘bubbly’ property markets of Sydney and Melbourne. The chart below depicts the performance of the Australian financials index since the beginning of 2016, overlaid with the 10-year Australian government bond yield. While not a perfect correlation, there is clearly a relationship between yields and the performance of financials. This being the case, investors positioning for higher interest rates over the next 12 to 18 months may want to consider a targeted investment to Australian financials through the SPDR S&P/ASX 200 Financials Ex-A-REIT Fund.