Investment market update - April 2013

April 2013

John-article-560x315

UniSuper's Chief Investment Officer John Pearce provides a market update for UniSuper members.
To print this update, download a PDF version.

 

 % Change
 Month FYTD 1 Year  3 Years p.a.  5 years p.a. 
Australian Shares (ASX 300)
 -2.3 25.4   19.2  5.0 2.9
US Shares (S&P 500)
3.8  17.2   14.0 12.7  5.8 
Asian Shares (MSCI Asia)
-1.4  11.9  4.8  3.3  1.4 
Australian Dollar (AUD/USD)
1.7  1.5  0.5  4.3  2.7 
Australian Fixed Interest (UBSA Composite)
-0.2  2.4  7.0  8.0  7.8 
Cash (UBSA Bank Bill)
0.2  2.5  3.6  4.4 4.7 
Balanced Option*  0.0  13.5  12.7  6.5  4.3 

Returns are for periods to 31 March 2013. Past performance is not an indication of future performance.
* Visit our Investment options, performance and holdings for performance information on all options.

Following a few months of strong outperformance, the Australian equity market underperformed most of the major international equity markets in March. While the Balanced option is heavily invested in Australian shares, it still managed to return a flat result for the month thanks to gains made in other parts of the portfolio. The recent weakness of the Australian market can be largely attributed to: 

  • further weakness in commodity prices, with the RBA commodity price index down 1.4% for the month 
  • a change in market expectations in relation to the Reserve Bank of Australia’s (RBA) monetary policy. While the RBA has left the door open to further interest rate cuts, they also state that the effects of previous easing of monetary policy are yet to be fully felt as they are still working through the system, and downside risks to the global economy have somewhat diminished. The market has inferred that rates are on hold, at least for the short term, and there is a growing school of thought that we have already seen the bottom of the current cycle
  • interest rates being on hold supporting a stubbornly high Australian dollar, while the terms of trade continue to decline. Such a combination does not support the Australian economy and company profits.

In terms of global developments, the big news of the month related to a small country: Cyprus. For those of you who didn’t have the time to follow the media reports, here is a summary of what happened and its implications.  

The trouble with Cyprus

As large holders of Greek bonds, Cypriot banks, as a group, suffered very big losses. On top of a general deterioration in their loan books, the losses sustained on Greek bonds have effectively placed the Cypriot banking system in a state of insolvency. 

The magnitude of the problem for Cyprus becomes even more acute when you consider that the assets of the banking system are about eight times the country’s gross domestic product (GDP). Compare this to Australian bank assets, which at about two times GDP are considered to be too high. Cypriot banks required a bailout of EUR17 billion, which a highly indebted government could not accommodate. Enter the European Central Bank (ECB), the International Monetary Fund (IMF), and a proposed solution that was bizarre to say the least.  

The initial proposal included a fee on all Cypriot bank deposits—6.75% on deposits up to EUR100,000 and 9.9% on all balances above EUR100,000. Not surprisingly the package caused outrage in Cyprus, particularly among small depositors who were led to believe that deposits up to EUR100,000 were “guaranteed” (albeit by an insolvent government). 

The Cypriot parliament duly rejected the proposed package, which has since been amended. The new package protects deposits under EUR100,000, but involves much larger fees on balances over EUR100,000. Large depositors have seen a major portion of their money (around 60%) converted into (potentially worthless) bank shares. Suffice to say that Cypriots are in for some very tough times.

Why Cyprus should not matter to global markets

Cyprus is an eastern-Mediterranean island with a population of 1.1 million, and a GDP of approximately EUR18 billion p.a., which is 0.2% of European output. To put this into context, China “creates” a Cyprus every two weeks! In addition, the size of the bailout required was actually quite small, and unlike the Lehman collapse, the extent of the problem is relatively simple to quantify. Hence, we are not dealing with too many “unknown unknowns”, such as massive off-balance sheet derivatives and myriad counterparty risks (the risk that a party to a contract will default on their contractual obligations).

Why the markets took fright 

The proposed solution to the Cyprus problem represents a hardline approach by the ECB and the IMF in that depositors are carrying the burden for recapitalising the banks (with Greece and other countries it was the bondholders). Some argued that such a hardline approach is totally warranted given that Cyprus is a tax haven, and large deposits represent the ill-gotten gains of Russian oligarchs and the like. 

That may be the case, but even so the initial proposal to hit small depositors was poorly thought through. The ensuing panic was inevitable, and was not going to be confined to Cyprus. It didn’t help when a senior German official suggested that the Cyprus solution represented a possible template to recapitalise other banks in Europe. Any small depositor in European peripheral countries would have understandably lost any comfort they took in government guarantees. The thought of hundreds of thousands of retail depositors forming queues outside banks in Greece, Portugal, Ireland, etc. was enough to send European markets into a tailspin.  

Ongoing implications  

At the time of writing, the situation in Cyprus appears to be under control, although given the imposition of capital controls, one cannot take much comfort from such appearances. It is a given that Cypriots are in for a torrid few years, although probably no more so than the Greeks or Portuguese. However, the fact that we have not seen runs on the banks in other European countries is positive, and while the Euro currency has weakened, it has not collapsed.

One gets the sense that although global sharemarkets are not immune to European shocks, the response to such shocks appears to be more muted. For example, the initial 3% fall in the Australian sharemarket in response to the Cyprus situation compares to the 11% fall during the first phase of the Greek crisis.

CIO-market-update-image-April-2013

Over the longer term one can envisage a situation in which the events in Europe have an ever-diminishing impact on Australia. Indeed, even today the Australian banking system has negligible direct exposure to Europe. Our real economy is impacted largely via the effect of European demand on our major trading partners, such as China. As the Asian region continues to expand its wealth and generate its own sources of final demand, reliance on Europe as a market will also diminish. Which of course brings us back to the major risk (and opportunity) confronting Australia over the medium to long term: China.    

Past performance is not an indicator of future performance. This information is of a general nature only and may include general advice. It has been prepared without taking into account your individual objectives, financial situation or needs. UniSuper’s investment strategies will not necessarily be appropriate for other investors. Before making any decision in relation to your UniSuper membership, you should consider your personal circumstances, the relevant product disclosure statement for your membership category and whether to consult a licensed financial adviser. This information is current as at 5 April 2013.

This is not intended to be an endorsement of any of the listed securities named above for inclusion in personal portfolios. The above material reflects UniSuper’s view at a particular point in time having regard to factors specific to UniSuper and its overall investment objectives and strategies.