Market Update – December 2011

While some global equity markets clawed back losses from previous periods in December – the US and the UK rising 1.4% and 1.2% respectively – the Australian share market finished a difficult 2011 in negative territory once again, with the ASX 300 Accumulation Index falling 1.4%. This amounted to a consecutive run of nine negative months, with the exception of October.

As had been the case for most of 2011, the main influence on market sentiment in December was the ongoing European sovereign debt crisis. During the month, an EU summit agreed measures to augment fiscal consolidation for member states via further government borrowing controls and initiatives were put in place to provide further capital support via the IMF.

Other factors at play during the month were signs of renewed strength in the US recovery where, apart from the upbeat leading indicators, recent data saw continued improvements in labour and housing markets. Less positive were figures out of China, which continue to point to a slowdown. While there is much discussion about the added pressure this brings to bear on the Australian share market, and in particular on the Resources sector, our Australian Equities boutique – informed by recent on-the-ground research – believes that the Chinese economy, while clearly not immune from slowing demand from its major trading partners, may well be stimulated by a government that has considerable levers at its disposal to encourage growth, given its tightening stance for most of 2011. In our view, this makes a ‘hard landing’ unlikely.

Sentiment for local share market investors was not helped by a swathe of negative news out of the retail sector, with a significant profit warning from Billabong and lowered earnings forecasts out of JB Hi-Fi and Kathmandu. Retailers have warned that November’s interest rate cut did not appear to have loosened consumer purse strings, so we wait with interest to see if figures out of the all-important Christmas and new year period were helped by the second rate cut in December, to a base rate of 4.25%.

On a more positive note, December did see some domestic corporate activity with Aston Resources and Whitehaven Coal announcing an intention to merge and Chinese miner Yanzhou Coal Mining making an offer for Gloucester Coal. We hold an overweight position in Gloucester Coal, and our recent focus on the mining services sector– which has taken us all over the country and further in the last couple of months – has seen us add to our positions in a few select mining companies like it where we believe the pipeline remains very strong for 2012.

In the fixed income space, markets’ favourable reactions to proposed initiatives out of the EU Summit and positive news out of the US saw a calmer December after one of the most volatile years in memory. Australian bond yields continued their rally in the first half of the month, but shorter-term yields had retraced by month-end – the three-year bond yield ended on 3.13% up from 3.12% and the 3-10s yield curve flattened to 54 basis points.

With confidence continuing to wane in the ability of European leaders to provide a credible solution and fears of a potential recession in Europe in 2012, our Income & Fixed Interest boutique expects financial markets to remain volatile in coming months. In order to replicate the strong results the team has produced across all funds in 2011, the key will be to continue to stick to the medium-term framework and maintain trading discipline at all times.

For more detailed commentary from our portfolio managers, read the December edition of our Fund Manager Commentary