View from the Hill - January 2012

View from the Hill

Hillross investment market performance at a glance including the feature article 'Why Australian shares are underperforming'. 

Australian shares

The calendar year 2011 ended on a negative note, with December’s 1.4% fall in the S&P ASX 200 Index bringing the annual decline to 10.5%. Concern over European government debt and the potential for this to generate losses and dysfunction in the global financial system was the major influence on equity markets.

Also heavily influencing investor confidence in 2011 was concern over the outlook for economic growth in China. Fears heightened that a slow-down in global economic growth combined with some tightening in Chinese government policy would result in a lower rate of expansion in demand from China. This lowering in expectations around Chinese economic growth resulted in the price of many commodities falling, which had a negative impact on Australian resource companies. The average price of resource stocks listed on the Australian market dropped by 25% over 2011. The fall in resource company share prices was the major reason why the Australian market performed worse than the global average in 2011.

Also weighing heavily on the Australian market over the past year was the finance sector, which dropped in price by an average of 11%. Although Australian banks continued to improve profitability and raise higher levels of domestic deposits, concerns over the global financial sector more generally led to a lack of support for local bank share prices.

There were, however, some positive performances on the Australian share market over 2011. Defensive stocks with a focus on the domestic economy tended to perform well. The telecommunication sector was 18% higher, whilst utilities increased 3% over the year. Although the consumer staples sector dropped by 5% in price, some stocks in this sector would have also finished the year in positive territory once dividends were accounted for.

Given the large presence of resource stocks within the smaller company universe, small cap stocks tended to underperform the market in 2011. The Small Ordinaries Index finished the year down 21%, with small resource companies falling 31% in price.

International shares

Although European debt was a dominant theme of concern across all global equity markets, there was a high degree of disparity in performance amongst major share markets over 2011. Virtually all markets lost value, although the United States (U.S.) was the stand out exception. Finishing the year unchanged from its opening level, the U.S. S&P 500 Index provided investors with slightly positive returns once dividends are taken into account. Improving economic data, including a reduction in unemployment, provided U.S. investors with some renewed confidence. This was particularly so in the final quarter of the year when the U.S. market advanced by 11%.

In addition to the European sovereign debt issues, global markets were also impacted by the tragic Japanese earthquake and Tsunami in March. This had significant economic consequences in some industries, with supply chains being heavily disrupted. The disaster contributed to the underperformance from the Japanese equity market, which finished the year down 17%.

Given the increased likelihood of an extended period of reduced government spending and higher taxes in Europe, there was a general lowering in economic growth expectations for the region over the medium term. This was accompanied by a significant decline across most continental European equity markets. The German DAX Index, for example, fell by 15% over the year. Possibly more distant from the worst impact of the adjustments required in Europe, the share market in the United Kingdom performed relatively well, with losses in the FTSE Index restricted to 6%.

Emerging markets experienced larger losses than most developed markets over the course of the year. Heavily influenced by commodity price trends and the outlook for China, the MSCI Emerging Market Index fell by 13% in local currency terms. Given the focus on a weaker outlook for China, Asian markets under performed with an average loss of 17% across the region.

With the Australian dollar opening and closing the year at around the U.S. 102 cent level, there was minimal difference in returns between hedged and unhedged international equity investments; with average losses for the year of 4% and 5% respectively.

Interest rates

With the exception of yields on government bonds of particularly heavily indebted nations, interest rates across the globe moved lower in 2011. The deterioration in the outlook for global economic growth was associated with the maintenance of loose monetary policy by most central banks and a general lowering in inflationary expectations. This resulted in longer term bond yields falling, creating positive returns for fixed interest investors. The United States 5-year Government bond yield fell from 2.0% at the beginning of 2011 to finish the year at 0.8%.

With Australia increasingly being viewed as a “safe haven”, there was strong support for Australian Government bonds. As a result, bond prices rose with the 5-year yield declining sharply from 5.4% to 3.3% last year. Australian interest rates were also impacted by the Reserve Bank shifting to a looser monetary policy stance late in the year, which led to a fall in the overnight cash interest rate from 4.75% to 4.25%.

Property

With interest rates falling, the yields available on property became more attractive in relative terms over 2011 and this provided some support for property investments. Although residential property prices remained subdued and impacted by low rental yields, there was some recovery in commercial property prices, with the Mercer Unlisted Property Index rising by 11%. The listed property sector was weighed down by retail (shopping centre) trusts, which were impacted by weak retail sales and some signs of structural changes in the industry. Overall, the S&P ASX 200 A-REIT Index fell by 1.5% over 2011.

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