Market Watch

After seven years of interest rate cuts and trillions of dollars in quantitative easing, discussion is growing over whether monetary policy is losing its effectiveness, given the growth outlook for advanced economies remains below 2%.

These measures have fallen short of stoking inflation to the degree major central banks had hoped, leaving economic growth sluggish and the macroeconomic backdrop somewhat mixed across regions.

However, the news is not all negative. Investment-grade corporate bonds generally do well where growth is subdued – whereby there is no anticipated deflation, nor runaway inflation as growth accelerates too strongly. So, that this may be seen as the proverbial sweet spot for investment-grade bonds (notably in the US), where economic growth of a subdued range of 1% to 3% is a general rule of thumb. US annualised economic growth is at about 1.2%.

In addition, the quantitative easing (QE) programs underway in Japan, Europe and the UK support corporate bonds as central banks buy up sovereign and corporate debt, as well as other risky assets (in the case of Japan) to spur inflation and, ultimately economic growth.

The Bank of England (BOE) recently began buying sterling-denominated corporate bonds as part of a plan to buy £10bn (US$13bn) worth of investment-grade corporate debt over 18 months3. In July, European Central Bank (ECB) President Mario Draghi confirmed the ECB would continue monthly asset purchase of €80bn (US$89bn) a month until the end of March 2017¹.

Meanwhile, the QE implemented by the ECB and the BOE are having a spillover effect, steering money into other regions where valuations are more attractive. This flow is evident in the US market. Foreign demand for US dollar assets has increased this year due in part to the QE-related flow of money, and central banks are expected to continue to drive that.

The US and Australia still have room to move

From a corporate bond perspective, investment-grade corporate bonds in the Australian and US markets are AMP Capital’s preferred areas of investment.

One reason for our positive view of US and Australian investment-grade corporate bonds is valuations within those two markets are slightly more supportive than those in the European market. In Europe, valuations offer less additional compensation outside of the enormous support that the central banks have already put into the market through QE.

In terms of Australia when you look at policy flexibility, Australia has got more flexibility, however ultimately a lower exchange rate may be needed as part of the effectiveness as monetary policy considerations and messaging occur.

From an interest rate perspective, where a higher relative cash rate and reasonably steep yield curves than those of other economies suggest the RBA can cut rates further if need be. There may be one further interest rate cut and if certain economic data, such as business investment and inflation, continue to disappoint, the RBA certainly has the currency and rate flexibility to continue to move.

Final thoughts

As central banks discuss, often publicly, whether more emphasis should be placed on fiscal policy to stimulate inflation from benign levels, uncertainty over the timing of a transition phase may give rise to greater volatility across asset classes.

We believe any shift away from monetary policy towards other stimulatory measures, such as fiscal policy, will be gradual. However, in the meantime, we are watching currency and rates markets closely for signs of disorderly adjustment to the next phase of the Federal Reserve’s planned policy-tightening cycle and other signs of central bank transition.

We see this as an opportunity to add risk due to underlying policy support, other broader macroeconomic data trends and valuation adjustments.

Source: AMP Capital

Article by David Carruthers, Head of Credit and Core, AMP Capital

¹ European Central Bank, Introductory Statement to the press conference, 21 July 2016 https://www.ecb.europa.eu/press/pressconf/2016/html/is160721.en.html

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.

At its meeting today, the Board decided to leave the cash rate unchanged at 1.50 per cent.

The global economy is continuing to grow, at a lower than average pace. Labour market conditions in the advanced economies have improved over the past year, but growth in global industrial production and trade remains subdued. Actions by Chinese policymakers have been supporting growth, but the underlying pace of growth in China has been moderating. Inflation remains below most central banks’ targets.

Commodity prices have risen over recent months, following the very substantial declines over the past few years. The higher commodity prices have supported a rise in Australia’s terms of trade, although they remain much lower than they have been in recent years.

Financial markets have continued to function effectively. Funding costs for high-quality borrowers remain low and, globally, monetary policy remains remarkably accommodative. Government bond yields are near their historical lows.

In Australia, the economy is continuing to grow at a moderate rate. The large decline in mining investment is being offset by growth in other areas, including residential construction, public demand and exports. Household consumption has been growing at a reasonable pace, but appears to have slowed a little recently. Measures of household and business sentiment remain above average.

Labour market indicators have been somewhat mixed. The unemployment rate has fallen further, although there is considerable variation in employment growth across the country. Part-time employment has been growing strongly, while growth in full-time employment has been subdued. The forward-looking indicators point to continued expansion in employment in the near term.

Inflation remains quite low. Given very subdued growth in labour costs and very low cost pressures elsewhere in the world, this is expected to remain the case for some time.

Low interest rates have been supporting domestic demand and the lower exchange rate since 2013 has been helping the traded sector. Financial institutions are in a position to lend for worthwhile purposes. These factors are all assisting the economy to make the necessary economic adjustments, though an appreciating exchange rate could complicate this.

Supervisory measures have strengthened lending standards in the housing market. Separately, a number of lenders are also taking a more cautious attitude to lending in certain segments. Growth in lending for housing has slowed over the past year. Turnover in the housing market has declined. The rate of increase in housing prices is lower than it was a year ago, although some markets have strengthened recently. Considerable supply of apartments is scheduled to come on stream over the next couple of years, particularly in the eastern capital cities. Growth in rents is the slowest for some decades.

Taking account of the available information, and having eased monetary policy at its May and August meetings, the Board judged that holding the stance of policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time.

Source: RBA October 4th 2016

Enquiries

Businesses that have succeeded for decades will become unseated by innovative start-ups and tech companies if they don’t adapt to rapid change. At AMP Capital, we looked at the potential impact driverless cars will have on insurers and the economy.

Disruption is proving to be a buzz word of 2016. Airbnb, Uber and Tesla have dominated the headlines and company boards have been taking trips to Silicon Valley to meet executives at tech darlings such as Twitter, Facebook and Google.

There is a sense that the world is spinning faster, ‘digital’ is driving rapid change, and businesses that have succeeded for decades may be unseated by innovative start-ups or simply become disintermediated if they do not adapt to this new digital world.

The analysis of disruption and other long-term industry drivers is an integral part of AMP Capital’s environmental, social and governance (ESG) research. In fact, in our detailed review of the Australian-listed insurance and diversified financial services sector, the risks and opportunities posed by driverless cars, the sharing economy, automation and blockchain feature heavily.

In contrast, traditional ESG research often focusses on the way in which particular companies manage ethical and governance risks and opportunities, skipping the social component of ESG research that can be a critical component of an investment decision.

The world is changing, and looking at the way in which insurers and diversified financials are positioning themselves for these changes can provide unique investment insights.

Ride-sharing and driverless cars

Perhaps the most significant long-term challenge for the insurance industry is the advent of driverless cars and the growth of the sharing economy.

These three questions crystallise the risks and opportunities for the mature motor insurance industry:

1. What if people no longer own their own vehicles?

2. What if cars drive themselves?

3. If cars don’t crash (or rarely crash) and you don’t own your own car (and/or rarely use a car), do you need insurance?

The reality is that car sharing is already occurring and the technology for driverless cars largely exists although cars are not fully autonomous just yet. In fact, driverless cars aren’t as Jetson-like in character as most of us would assume. They are simply cars that use sensors, cameras, GPS technology and short-range radio communications to talk to each other as well as the roads and infrastructure. They then use that information to drive the car automatically.

Some are forecasting that fully autonomous cars will be on the road in Australia by 2025. Others say autonomous cars will not be mainstream until 2040. But of course, the speed and extent of adoption of both trends depends on a range of factors, not just technology, and there are natural inhibitors to both forms of disruption that need to be considered when assessing the potential impact. The potential impact, however, is large.

The impact on insurers

Motor books are extremely significant to the earnings of Australian and global insurers. Personal and CTP insurance account for approximately 50 per cent of Suncorp’s premiums and 44 per cent of IAG’s premiums, according to Bank of America Merrill Lynch, and 42 per cent of the world’s property and casualty premiums are motor. In emerging markets, motor insurance is an even greater proportion of property and casualty premiums, at 58 per cent of the total.

Irrespective of if or when the tipping point occurs, there are a number of short and medium-term impacts for insurers as the technology that underpins driverless cars, such as auto-braking systems and laneway departure warning systems, appears in new cars. In the short to medium term, it is thought that claims costs will reduce because semi-automated cars will significantly reduce the number of accidents on roads. According to Bank of America Merrill Lynch, collision claims account for about 80 per cent of the total claims cost on the average comprehensive motor policy in Australia and about 54 per cent of motor vehicle premiums.

This suggests that, if automation technology reduces car collisions to the extent expected, motor premiums may fall by up to 50 per cent without impacting insurers’ margins. This neatly demonstrates disruption in action: it can bring opportunities as well as challenges.

The sharing economy is likely to be impacting insurers at the same time, with some researchers saying that ‘peak car ownership’ has already passed, thanks to Uber and cheap car rental services like GoGet in urban centres. According to KPMG, owning a car in the US today costs about US82 cents per mile travelled, on average, while the cost of a shared car costs about US44 cents per mile, on average.

In Australia, fewer 18 to 24 year olds see the need to get their driver licenses. One-third of 18-24 year olds in Victoria don’t have a license, according to Victorian motoring organisation the RACV. In 2014, there were 12 per cent fewer 18 to 24 year olds in Victoria that held a license than there were in 2001.

Understanding ESG issues can lead to better investment outcomes

Disruption aside, AMP Capital’s ESG research demonstrates there is a strong positive correlation between the way companies manage short, medium and long-term ESG risks and opportunities and their investment performance.

In our sector review that included detailed analysis of driverless cars, the sharing economy and bitcoin, the five companies with the highest ESG scores outperformed the five companies with the lowest ESG scores every year over five consecutive years.

When measured over a longer time frame (10 years), the outperformance was even stronger. The only exception to this is when performance is measured over seven years.

Underperformance of good ESG companies on this timeframe appears due to the global financial crisis and high share prices in 2009 in the lead-up to the global contagion.

The outperformance of ESG stocks over most periods demonstrates the value in considering the way in which companies are managing short and long-term ESG issues when making investment decisions.

Read the full report here

Source: AMP Capital

About the author
By Kristen Le Mesurier, Senior ESG Analyst, Investment Research

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.

At its meeting today, the Board decided to leave the cash rate unchanged at 1.50 per cent.

The global economy is continuing to grow, at a lower than average pace. Several advanced economies have recorded improved conditions over the past year, but conditions have become more difficult for a number of emerging market economies. Actions by Chinese policymakers have been supporting growth, but the underlying pace of China’s growth appears to be moderating.

Commodity prices are above recent lows, but this follows very substantial declines over the past couple of years. Australia’s terms of trade remain much lower than they had been in recent years.

Financial markets have continued to function effectively. Funding costs for high-quality borrowers remain low and, globally, monetary policy remains remarkably accommodative.

In Australia, recent data suggest that overall growth is continuing, despite a very large decline in business investment, helped by growth in other areas of domestic demand and exports. Labour market indicators continue to be somewhat mixed, but suggest continued expansion in employment in the near term.

Inflation remains quite low. Given very subdued growth in labour costs and very low cost pressures elsewhere in the world, this is expected to remain the case for some time.

Low interest rates have been supporting domestic demand and the lower exchange rate since 2013 is helping the traded sector. Financial institutions are in a position to lend for worthwhile purposes. These factors are all assisting the economy to make the necessary economic adjustments, though an appreciating exchange rate could complicate this.

Supervisory measures have strengthened lending standards in the housing market. Separately, a number of lenders are also taking a more cautious attitude to lending in certain segments. The best available information suggests that dwelling prices overall have risen moderately over the past year and growth in lending for housing purposes has slowed. Considerable supply of apartments is scheduled to come on stream over the next couple of years, particularly in the eastern capital cities.

Taking account of the available information, and having eased monetary policy at its May and August meetings, the Board judged that holding the stance of policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time.

Source: RBA September 6th 2016

Enquiries

Global markets rally

Global markets have delivered solid gains after the Brexit vote. Factors driving the strength in shares have been fairly consistent. Economic data have been respectable and June quarter corporate profits in the US have been well up on the previous quarter.

In addition, central banks have delivered a broadly consistent message of easy monetary policy, supporting improved investor sentiment.

Global market outlook

The Brexit decision helped clear much of the concern overhanging global shares and fuel the recent rally. However, the rally has left shares slightly overbought from a technical perspective. Given that August and September are traditionally more difficult months for shares due to seasonal factors, markets could undergo some consolidation in the short term.

But looking further out, it’s reasonable to expect increases in share prices over the next six to 12 months, given the global economy is still growing and interest rates are very low. The combination should flow through to stronger company profits.

Australian economy solid despite the end of mining boom

The Australian economy is doing reasonably well. We’ve been growing at a pace of about 3% which is far stronger than most other developed economies. The end of our mining boom brought on a fair bit of doom and gloom, with widespread expectations that Australia would slide into recession.

However, that hasn’t happened. Why? Mainly, it’s because interest rates have fallen and partly reflect that the Australian dollar has come down. Taken together, these two factors have helped those parts of the economy that were struggling through the course of the mining investment boom. In addition, we are going through the third and final phase of the mining boom, which is the export volumes that come out of the completed resource projects.

Outlook for the remainder of the year

Although Australia’s economy is growing faster than most other developed economies, our inflation rate remains too low for comfort. In late July, inflation slid to a 17-year low of an annual 1%. The Reserve Bank of Australia (RBA) worries that if inflation remains at these low levels, it will become entrenched. If we get a downturn at some stage, that could tip us into deflation. So, the RBA has cut interest rates a few times this year.

We expect to see another rate cut to come, probably in November. Besides attempting to spur inflation from its chronically low levels, the RBA is also conscious that interest rates in the rest of the world are near zero. That puts upward pressure on the value of the Australian dollar. If the RBA does nothing to combat that, the Australian dollar will keep rising, creating difficulty for our economy.

In summary, the Australian economy is doing well but inflation is low. Because of the low inflation rate, the RBA can be expected to cut rates at least once more in coming months.

Source: AMP Capital

Shane Oliver

Dr Shane Oliver has extensive experience analysing economic and investment cycles and how current positioning affects the return potential for asset classes such as shares, bonds, property and infrastructure. Shane is a regular media commentator, providing economic forecasts and analysis of key variables and issues that affect all asset markets.

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.

At its meeting today, the Board decided to lower the cash rate by 25 basis points to 1.50 per cent, effective 3 August 2016.

The global economy is continuing to grow, at a lower than average pace. Several advanced economies have recorded improved conditions over the past year, but conditions have become more difficult for a number of emerging market economies. Actions by Chinese policymakers are supporting the near-term growth outlook, but the underlying pace of China’s growth appears to be moderating.

Commodity prices are above recent lows, but this follows very substantial declines over the past couple of years. Australia’s terms of trade remain much lower than they had been in recent years.

Financial markets have continued to function effectively. Funding costs for high-quality borrowers remain low and, globally, monetary policy remains remarkably accommodative.

In Australia, recent data suggest that overall growth is continuing at a moderate pace, despite a very large decline in business investment. Other areas of domestic demand, as well as exports, have been expanding at a pace at or above trend. Labour market indicators continue to be somewhat mixed, but are consistent with a modest pace of expansion in employment in the near term.

Recent data confirm that inflation remains quite low. Given very subdued growth in labour costs and very low cost pressures elsewhere in the world, this is expected to remain the case for some time.

Low interest rates have been supporting domestic demand and the lower exchange rate since 2013 is helping the traded sector. Financial institutions are in a position to lend for worthwhile purposes. These factors are all assisting the economy to make the necessary economic adjustments, though an appreciating exchange rate could complicate this.

Supervisory measures have strengthened lending standards in the housing market. Separately, a number of lenders are also taking a more cautious attitude to lending in certain segments. The most recent information suggests that dwelling prices have been rising only moderately over the course of this year, with considerable supply of apartments scheduled to come on stream over the next couple of years, particularly in the eastern capital cities. Growth in lending for housing purposes has slowed a little this year. All this suggests that the likelihood of lower interest rates exacerbating risks in the housing market has diminished.

Taking all these considerations into account, the Board judged that prospects for sustainable growth in the economy, with inflation returning to target over time, would be improved by easing monetary policy at this meeting.

Source: RBA August 2nd 2016