Despite two positive potential catalysts this week, the Australian share market has maintained the sideways trading pattern that has prevailed since the middle of May. Early this week a much anticipated announcement came when the Australian Prudential Regulation Authority defined what it means for our banks to be ”unquestionably strong”, a phrase taken from the final report of the Financial System Inquiry. The banks have been building their capital for several years and are already quite close to the increased capital ratio set out by APRA, well ahead of the January 2020 deadline. This benign outcome saw the banking sector rally by more than 5% across Wednesday and Thursday’s trading.
We also had labour market data released this week and saw a continuation of the strong recent trend in jobs growth, particularly in full time jobs. An uptick in the participation rate meant that the unemployment rate remained steady at 5.6%, though importantly the underemployment rate drifted lower to 8.4%. This is an encouraging sign for the health of the Australian economy, though as we have mentioned before it will be especially welcome to see strength in employment data translate into improvements in wages data.
ASSET ALLOCATION & INVESTMENT COMMITTEE
With the sideways move described above the forecast returns for Australian Equities have remained relatively steady over the last several months. As a result the committee has affirmed the active overweight to this asset class at our meeting this week. We are however making a subtle adjustment within the constituent investments which will see a reduction in the Financials ETF (OZF) and a reallocation of this exposure to the more broadly diversified ASX50 ETF (SFY). In analysing this asset class we look through the ETFs to the underlying holdings and assess the aggregate sector exposures, which in Australia are dominated by Financials. We remain comfortable that an overweight to Financials is appropriate given our forecast, but have deemed it appropriate to enhance the diversification within this asset class. We will implement this change in a couple of tranches over coming months, ideally as the relief rally in the banks continues and we see higher prices at which we can complete this adjustment.
A more optimistic outlook for our economy has seen a significant change in expectations about interest rates. The most obvious reflection of this move has been a strong rally in the Australian dollar, which approached US$0.80 this week. A similar move against the Yen has held back the Japanese ETF, but the much more modest move against the Euro has meant a still pleasing contribution to performance from the Developed Europe (ExUK) ETF. That said, our long-term forecasts which allow for currency impact over time, continue to support the exposure to both Japan and Europe. Rising bond yields over the last month have negatively impacted the Listed Property exposure, where the active stance has been an underweight for almost the last year. The committee agreed to maintain that underweight exposure for now. On the defensive side we have seen a strong rally in the major bank listed preference shares, where the income you receive increases as underlying interest rates increase.
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