Market Review | Commentary
QUARTERLY MARKET UPDATE
Shares continue to rise
Share markets continued to rally strongly in developed economies through the third quarter of 2019 with major stock markets in Australia, Europe and the US all making returns in excess of 18% since the beginning of the year (in local currency terms). The Australian dollar depreciated against the US dollar over the quarter from a level of 70 US cents to 67.6 US cents providing an additional benefit for Australians investing in global equities.
Emerging market shares have not fared nearly as well with the MSCI Emerging Market Index falling 5.11% in local currency terms over the quarter.
The strong gains being enjoyed by global share markets, do not however appear to be supported by improving macroeconomic fundamentals. Many of the issues we have previously highlighted, which we would expect to weigh on stock markets, have intensified, rather than dissipated, through 2019.
Trade wars escalate
Trade tensions between the US and China escalated through the Northern Hemisphere summer with numerous talks and negotiations between the world’s two largest economies proving fruitless. US President Donald Trump’s war on China broadened in scope to include visa bans for Chinese officials linked to human rights violations and blacklisting Chinese tech giants involved in video surveillance and Artificial Intelligence technology. Additionally, there were rumoured moves by the US to restrict capital flows into China and pressure major index providers to reduce the weight to Chinese securities in their benchmark indices.
Economic data released in recent months indicates that the economic fallout from the tariff wars is real and growing. US manufacturing output is now in decline and the new head of the International Monetary Fund (IMF) has warned that a world which was in “synchronized upswing” just two years ago is now staring down the barrel of a “synchronized slowdown” due to trade tensions. 
Interest rates cut
Interest rates are very low globally and as widely expected, the Reserve Bank of Australia (RBA) made further interest rate cuts during the September quarter. The RBA cut interest rates by 0.25% in July and again on the 1st of October, taking the Australian cash rate to a record low 0.75%.
The good news is that rate cuts are bringing down borrowing rates for both businesses and households, although the major banks failed to pass through the reduction to borrows in full, despite very vocal political pressure. The bad news, however, is that the rate cuts don’t appear to be having much impact on the broader economy as economic growth and inflation both remain weak (the Australian economy expanded by only 1.4% over the year to 30 June 2019). 
Savings rates continue to fall and net savers who do not have a mortgage (including many self-funded retirees) have seen interest rates on their savings reduced. The RBA has warned that monetary policy can only do so much and called for the government to inject more infrastructure spending and structural reforms into the economy to boost sluggish growth. These comments had economists and market commentators start debating the possibility of negative interest rates in Australia. With the cash rate at 0.75%, the RBA is starting to run out ammunition.
Central banks around the world appear to be co-ordinated in their dovish (more likely to reduce than increase) view towards interest rates. More than a decade on from the Global Financial Crisis, the US Federal Reserve reduced the Fed Funds rate in both August and September. The European Central Bank followed suit cutting interest rates and announcing additional support in the form of buying bonds (quantitative easing). Many central banks have signalled their intent to hold interest rates steady, or even reduce them, in the face of economic uncertainty and low inflation expectations.
Outlook & portfolios
Share markets have had a phenomenal run since the start of 2019 with major developed markets all gaining over 18% (in AUD terms) and a number of stock market indices flirting with all-time highs. Worryingly, the underlying economic fundamentals do not appear to be supportive of such lofty share market valuations with many major economies facing stubbornly low wage and productivity growth and an uncertain outlook for corporate earnings. Inflation, as measured by the price change of consumable goods and services, has been below the levels targeted by central banks in order to support robust economic growth. However, as central banks continue to provide very easy money there is an increasing threat of inflation lurking not through consumption goods and services, but rather in the form of growing asset bubbles in the residential and commercial property sectors and global share markets which continue to make new highs.
We expect there to be continued volatility in markets with the growing geopolitical risks and challenging economic growth outlook providing headwinds to future returns. Despite the less positive outlook for share markets, we don’t recommend allocating away from growth assets and into cash as it is extremely difficult to time the market accurately. Instead of attempting to make tactical changes to asset allocations, we recommend including an allocation to strategies with a specific focus on downside protection and capital preservation in portfolios. This allocation will reduce the severity of drawdowns and provide a smoother ride over the long term. Now, more than ever, it is crucial to invest in high quality investments managed by experienced and well-resourced managers.
 Returns as measured by S&P/ASX 200, Euro Stoxx and S&P 500 Price Indices.
 Australian Financial Review, 10 October 2019
 Reserve Bank of Australia
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