Market Watch

The story so far…

• After sharp interest rate cuts by the Fed at the outset of the global financial crisis, quantitative easing (QE) began in November 2008 with the Fed buying US$1.25 trillion of mortgage-backed securities and $175 billion of agency debt in order to boost money supply.

• With few signs the US economy was recovering the Fed embarked on a second program of bond purchases, buying US$600 billion of longer-term US Treasury securities from November 2010.

• The third round of quantitative easing commenced in September 2012 and involved the Fed purchasing agency mortgage-backed securities. The targeted total value and timeframe were open-ended and initially involved purchases totalling US$40 billion per month which grew to US$85 billion per month.

• With the US economy showing signs of stabilising, the Fed announced in June 2013 that it planned to begin tapering its bond-purchasing program – with the value of bonds purchased to be gradually reduced in accordance with how the recovery was progressing.

• This tapering commenced in December 2013, and saw monthly bond purchases gradually decrease to the current level of US$15 billion per month.

Update on QE tapering and the outlook for interest rates

 On the one hand, the US economy has improved enough to allow the Fed to continue tapering its quantitative easing program throughout 2014 without causing too many dramatic disturbances in investment markets. On the other hand, it’s unclear that conditions are strong enough to warrant interest rate hikes just yet. This is something the Fed is grappling with, but the conclusion seems to be that – with inflation and wages growth at low levels and excess capacity in the labour market remaining – the Fed is unlikely to rush into raising rates.

The Fed currently states that it anticipates a ‘considerable time’ between the ending of quantitative easing and the first rate hike, with this taken to mean six months or more. With quantitative easing ending in October, we expect the first rate hike is likely to be in the June quarter of 2015.

What does this mean for investment markets?

With quantitative easing ending in the US and interest rate rises on the cards within the next 12 months, implications across each asset class vary.

• Equities: The experience around the initial flagging of tapering last year which saw shares fall 5-10% warns of the risk of a correction in the run up to and/or in response to the first rate hike. But beyond a short-term upset, the initial monetary tightening is unlikely to be a huge problem for shares. Historical experience tells us that the start of a monetary tightening cycle is not necessarily bad for shares. This is because in the early phases of a tightening cycle, higher interest rates reflect stronger economic and profit growth. It’s only as rates rise to prohibitive levels that suppress inflation that it becomes a problem.

• Fixed income: The commencement of a monetary tightening cycle in the US is expected to put upwards pressure on US and global bond yields in response to the uncertainty as to how high rates will ultimately go. A 1994-style bond crash is a risk but is unlikely – as the more constrained US and global growth and inflation backdrop this time around will likely mean that the monetary tightening cycle will be more gradual than in 1994.

• Real estate: Higher longer-term bond yields will likely make the relative yield from real estate slightly less attractive. As one of the beneficiaries of the reach for yield in the absence of attractive yields being offered by bonds, direct and listed real estate is vulnerable to a sharp rise in bond yields should it occur.

• Australian dollar: Progress towards eventual rate hikes in the US will put further downwards pressure on the Australian dollar.

Generally speaking, the end of quantitative easing and eventual US interest rate increases should be viewed by all investors as a good sign – after six years the US economic recovery is well underway and solid enough to withstand the start to more normal monetary conditions.

While uncertainty regarding the timing and magnitude of US interest rate increases is likely to keep flaring up periodically, on balance the move is a positive indicator as it signifies a brighter long-term outlook for the US economy (and therefore investors).

The fact that each assets class will be impacted in a differing way – and to a differing extent – is a timely reminder of the importance of maintaining a well-diversified portfolio.

About the Author  Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP Capital is responsible for AMP Capital's diversified investment funds. He also provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets.

Important note: While every care has been taken in the preparation of this information, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) makes no representation or warranty 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 information 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, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. Certain information in this website has been obtained from sources that we consider to be reliable and is based on present circumstances, market conditions and beliefs. We have not independently verified this information and cannot assure you that it is accurate or complete.

The story so far…

• After sharp interest rate cuts by the Fed at the outset of the global financial crisis, quantitative easing (QE) began in November 2008 with the Fed buying US$1.25 trillion of mortgage-backed securities and $175 billion of agency debt in order to boost money supply.

• With few signs the US economy was recovering the Fed embarked on a second program of bond purchases, buying US$600 billion of longer-term US Treasury securities from November 2010.

• The third round of quantitative easing commenced in September 2012 and involved the Fed purchasing agency mortgage-backed securities. The targeted total value and timeframe were open-ended and initially involved purchases totalling US$40 billion per month which grew to US$85 billion per month.

• With the US economy showing signs of stabilising, the Fed announced in June 2013 that it planned to begin tapering its bond-purchasing program – with the value of bonds purchased to be gradually reduced in accordance with how the recovery was progressing.

• This tapering commenced in December 2013, and saw monthly bond purchases gradually decrease to the current level of US$15 billion per month.

Update on QE tapering and the outlook for interest rates

 On the one hand, the US economy has improved enough to allow the Fed to continue tapering its quantitative easing program throughout 2014 without causing too many dramatic disturbances in investment markets. On the other hand, it’s unclear that conditions are strong enough to warrant interest rate hikes just yet. This is something the Fed is grappling with, but the conclusion seems to be that – with inflation and wages growth at low levels and excess capacity in the labour market remaining – the Fed is unlikely to rush into raising rates.

The Fed currently states that it anticipates a ‘considerable time’ between the ending of quantitative easing and the first rate hike, with this taken to mean six months or more. With quantitative easing ending in October, we expect the first rate hike is likely to be in the June quarter of 2015.

What does this mean for investment markets?

With quantitative easing ending in the US and interest rate rises on the cards within the next 12 months, implications across each asset class vary.

• Equities: The experience around the initial flagging of tapering last year which saw shares fall 5-10% warns of the risk of a correction in the run up to and/or in response to the first rate hike. But beyond a short-term upset, the initial monetary tightening is unlikely to be a huge problem for shares. Historical experience tells us that the start of a monetary tightening cycle is not necessarily bad for shares. This is because in the early phases of a tightening cycle, higher interest rates reflect stronger economic and profit growth. It’s only as rates rise to prohibitive levels that suppress inflation that it becomes a problem.

• Fixed income: The commencement of a monetary tightening cycle in the US is expected to put upwards pressure on US and global bond yields in response to the uncertainty as to how high rates will ultimately go. A 1994-style bond crash is a risk but is unlikely – as the more constrained US and global growth and inflation backdrop this time around will likely mean that the monetary tightening cycle will be more gradual than in 1994.

• Real estate: Higher longer-term bond yields will likely make the relative yield from real estate slightly less attractive. As one of the beneficiaries of the reach for yield in the absence of attractive yields being offered by bonds, direct and listed real estate is vulnerable to a sharp rise in bond yields should it occur.

• Australian dollar: Progress towards eventual rate hikes in the US will put further downwards pressure on the Australian dollar.

Generally speaking, the end of quantitative easing and eventual US interest rate increases should be viewed by all investors as a good sign – after six years the US economic recovery is well underway and solid enough to withstand the start to more normal monetary conditions.

While uncertainty regarding the timing and magnitude of US interest rate increases is likely to keep flaring up periodically, on balance the move is a positive indicator as it signifies a brighter long-term outlook for the US economy (and therefore investors).

The fact that each assets class will be impacted in a differing way – and to a differing extent – is a timely reminder of the importance of maintaining a well-diversified portfolio.

About the Author  Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP Capital is responsible for AMP Capital's diversified investment funds. He also provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets.

Important note: While every care has been taken in the preparation of this information, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) makes no representation or warranty 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 information 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, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. Certain information in this website has been obtained from sources that we consider to be reliable and is based on present circumstances, market conditions and beliefs. We have not independently verified this information and cannot assure you that it is accurate or complete.

The growth in online shopping has caused some to question how this will affect traditional retail stores, and what this effect will ultimately have on investments. In this article we examine some of the opportunities investors can consider in light of the rising trend of online shopping.

Companies that are able to capture new revenue through online spending will be rewarded

In all sectors internet shopping is rising at a rapid rate. While this rising trend has come from small beginnings, any time there is a disruptive trend, it’s important for investors to be astute and carefully watch those companies that may previously have been regarded as well-established and ‘safe’.

We believe the companies that will be successful will be those who are able to restructure their businesses in response to changing economic and consumer circumstances. This may include transitioning business models to accommodate online shoppers by improving websites, expanding product offerings, and focusing on innovative ways to deliver products from point of purchase to customers.

Consider businesses who sell exclusively online

Other opportunities for investors from online shopping include successful businesses that are exclusively online, such as Amazon and Overstock. In Australia, a similar business includes OzSale which has no traditional store, and whose business model involves selling solely online.

It’s not the end of traditional retail shopping!

While there is certainly a rise in online spending, we don’t believe that this heralds the end of traditional retail shopping. Many retail properties have embarked on redevelopment plans to transform centres into entertainment destinations and there has been an expansion of highly regarded global brands entering the Australian retail market.

Japanese retailer UNIQLO, Swedish retailing giant H&M and Spanish trend setter Zara have all set up shop in Australia. Many of these retailers have been motivated to open in Australia after seeing strong Australian buyer interest in their online sites. As such, the growing trend of online shopping has actually revealed to many global retailers that Australia is a bit of an untapped ‘Treasure Island’!

AMP Capital Shopping Centres Managing Director Bryan Hynes has said the quality of the international retailers coming to retail centres such as Macquarie Centre, New South Wales’ largest retail centre, only confirms the strength of redevelopment moves. This will transform the centres’ retail offering and customer experience.

For investors in listed and direct property the expansion of highly regarded brands seeking to do more retail business in Australia could support leasing activity, and as a result underpin the yield offered by these assets as landlords drive income growth by undertaking opportunities or expansion, refurbishment and development.

About the Author  Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP Capital is responsible for AMP Capital's diversified investment funds. He also provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets.

Important note: While every care has been taken in the preparation of this information, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) makes no representation or warranty 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 information 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, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. Certain information in this website has been obtained from sources that we consider to be reliable and is based on present circumstances, market conditions and beliefs. We have not independently verified this information and cannot assure you that it is accurate or complete.

The outlook for banks

We believe that banks look fully priced for a rising market. The key weakness of the Australian banking system is a low level of deposits relative to loans. To cure this, banks are ‘overpaying’ for deposits, and it’s our view that this isn’t going to change any time soon. Indeed, this is a key reason why mortgage rates are higher relative to the Reserve Bank of Australia cash rate than recent historical experiences.

With ongoing regulatory change, and a high starting point, this means that, net interest margins and future return on equity may not be as good as they have been. (Net interest margins measure the difference between interest income generated by banks and the amount of interest paid out to their lenders such as through deposits.) As such, we think investors should prepare for a period of lower return on equity from bank stocks.

How exposed are you to bank stocks?

With more than 30% of the Australian share index made up of the ‘Big 4’ banks, it’s important that investors take steps to address this concentration of risk.

We took a look at the average super fund’s exposure to the sector as well as the average SMSF investor. While it’s hard to get exact data regarding SMSF investors’ exposure, we made the assumption that their Australian share holdings were invested in very large Australian listed companies, and mimicked the ASX20 Index. Using this approach, when it comes to investments in bank stocks, the average SMSF investor holds more than double the risk in their portfolios than that of the average super fund. And interestingly, it’s not just the banking sector that SMSF investors could have high exposure to. Their portfolios may also have a greater degree of concentration risk around Mining, Property Trusts, as well as Staples and Telecommunications sectors compared to the average super fund.

What should investors do about this?

Clearly, it’s important that investors take steps to manage any risks around high concentration. There are a number of ways exposure can be reduced:

• One way is to consider investing against global benchmarks where there is less concentration risk by sector.

• Another tactic is to give greater discretion to active managers who avoid ‘hugging’ the benchmark and invest only into stocks where they have high conviction on future returns.

• Further, goals based funds also tend to have significantly less sector risk, given their more holistic risk management approach, and, in some cases, active tail risk management.

Important note: While every care has been taken in the preparation of this information, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) makes no representation or warranty 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 information 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, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. Certain information in this website has been obtained from sources that we consider to be reliable and is based on present circumstances, market conditions and beliefs. We have not independently verified this information and cannot assure you that it is accurate or complete.

More work to be done to stimulate the economy

Rates have been reduced to help stimulate the economy. Lending rates on housing and business loans have decreased, and this has seen a pick-up in house prices, approvals to build new homes and some improvement in retail sales. However, the Australian dollar remains high, and with mining investment still falling, and some uncertainty about other parts of the economy, we believe it’s still too early to declare victory and begin raising rates. In fact, the Reserve Bank of Australia has flagged that low interest rates are likely to remain in place for a period ahead, which, in our view, could take us well into 2015.

The effect of low rates on term deposits

So, what does this mean for term deposit holders? Well, they’re likely to remain low for some time to come, and may even fall further. As a result of low rates, we’re likely to see the search for more attractive income or ‘yield’ continue. Such conditions make life difficult for those investors who have a fixed rate of return in mind, particularly those with term deposits and other cash-like investments which form a core part of their investment strategy.

Where can investors go in the search for yield?

Corporate bonds, infrastructure and property all have comparatively higher yield than term deposits and can be a good source of income. In addition, Australian shares have also been a great provider of income. In Australia, we’re fortunate in that we have high dividend payout ratios for corporates, and the franking credit system encourages the payment of decent dividends. Dividends are great for investors as they provide a relatively stable and attractive source of income, and can provide a degree of security in uncertain and volatile times.

To learn more about the benefits of dividends and investing in shares, please read 'Why I love dividends and you should too' by Dr Shane Oliver, AMP Capital.

Important note: While every care has been taken in the preparation of this information, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) makes no representation or warranty 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 information 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, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. Certain information in this website has been obtained from sources that we consider to be reliable and is based on present circumstances, market conditions and beliefs. We have not independently verified this information and cannot assure you that it is accurate or complete

Myth 1: Infrastructure is a boring old 'economy style' investment

A common misconception is that infrastructure assets represent, for the most part, old economy style investments with little potential for growth and limited relevance to future economic needs. In reality nothing could be further from the truth. Consider some of the key global secular themes that are shaping the future of investment markets (such as water, communications, shale gas, electricity production)… infrastructure assets lie at the core of many of these. McKinsey estimates that US$57 trillion will be spent on Infrastructure worldwide by 2030.

Myth 2: Infrastructure assets are very susceptible to interest rate hikes

In reality, infrastructure assets typically exhibit qualities that provide dual protection against rising interest rates. Firstly, infrastructure companies have longer-term debt structures. This means they are only obliged to refinance small proportions of their debt in the short-term but have the option to refinance longer-term debt at favourable rates should market conditions allow. Secondly, contracts and regulation are often negotiated on a ‘cost-plus’ basis allowing charging structures to be increased in an environment of rising interest rates. In addition, if interest rates rise due to an increase in GDP, then this provides natural economic support and an associated increased demand for infrastructure assets.

Myth 3: Listed infrastructure returns have run out of steam

Yes, the asset class has performed well over the last five years, but does this mean it’s run out of steam? Not necessarily. The asset class ‘overcorrected’ during the Global Financial Crisis, and we believe it’s only recently returned to its long-term growth trend. This means it still has plenty of upside potential given the fundamentals.

Final thoughts

In a low interest environment with the associated chase for yield, an asset class which exhibits a defensive and stable yield profile, coupled with strong potential for growth, is an obvious candidate for consideration in any well considered long-term investment strategy. This relatively new asset class also affords exposure to the type of investment previously only accessible by institutional investors.

	About the Author Tim Humphreys is the head of AMP Capital's Global Listed Infrastructure Team with over 15 years' experience in the UK and Australia. Tim also leads the research effort of infrastructure companies in the Americas.

Important note: While every care has been taken in the preparation of this information, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) makes no representation or warranty 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 information 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, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. Certain information in this website has been obtained from sources that we consider to be reliable and is based on present circumstances, market conditions and beliefs. We have not independently verified this information and cannot assure you that it is accurate or complete.