A sharp sharemarket correction was followed by a solid rally in developed nations.
The surprise vote by Britain to exit the European Union on June 23 (Brexit) drove a sharp sharemarket correction. Hardest hit were banks and financials, sectors that are generally supported by higher interest rates and yields.
This correction was then followed by a solid rally, led by the US and Britain. Bond-related sectors supported the rally, with strong returns from consumer staples, utilities, real estate investment trusts, gold and telecommunications.
Other sectors that rebounded, such as energy and metals and mining, responded to expectations that growth may improve somewhat and the US dollar would remain capped due to the US Federal Reserve (Fed) pushing back interest rate rises.
British shares were propped up by the sharp decline in the pound sterling, which favoured offshore exposures.
A legacy of lower interest rates
Brexit is clearly a medium-term challenge for Britain, and to some extent Europe, although its affect on global growth may be modest.
A key near-term legacy of Brexit is to reinforce the long-standing “lower for longer” trend of lower bond yields – which are now negative across many markets including Switzerland, Germany, Japan, and Sweden.
This trend reflects market expectations that central banks will keep interest rates on hold or provide further policy support to boost growth and provide ample liquidity.
Australian rates on hold for now
After cutting interest rates by 0.25 per cent in May, the Reserve Bank of Australia (RBA) kept rates on hold in June, despite market expectations of another cut this year.
While Australian inflation and wages remained soft, gross domestic product lifted strongly at 1.1 per cent over the quarter and 3.1 per cent over the year. This result suggests the economy continues to weather the downturn in mining investment.
Solid consumer spending and strong growth in both housing construction and exports helped to offset the slump in mining investment. However, apartment approvals appear to be easing, suggesting a softening in construction in 2017.
Asset class summary
Global developed market shares were down 1.2 per cent in US-dollar terms. European shares fell 6.4 per cent in local currency terms as concerns of contagion led to a reduced risk appetite. US shares were flat while British shares were up strongly. Meanwhile, Japanese shares fell 9.7 per cent as the higher yen dampened future prospects for earnings.
Emerging market shares were up 3.3 per cent in US-dollar terms, led by strong returns in Brazil where higher commodity prices benefited earnings growth.
Australian shares recovered solidly in late June, but returns were still down 2.4 per cent. The resilience of the Australian dollar resulted in lower returns on an unhedged basis.
Global fixed income performed strongly with a 2 per cent gain, largely supported by soft growth and the prospect of further central bank stimulus.
Australian fixed income rose 1.3 per cent, buoyed by expectations of further RBA rate cuts.
In currencies, the “risk off” environment favoured the US dollar and the Japanese yen, with the pound sterling down 8.3 per cent against the US dollar. Elsewhere, expectations for delayed Fed rate hikes boosted the Australian dollar (up 3.0 per cent) and the New Zealand dollar (up 5.5 per cent).
See the CIO Market Watch report for June.
Chief investment office