Asset class overview
The economic and credit market stresses continue
The December quarter was one of the toughest ends to a year that investors have ever seen. The primary driver of the volatility in all global financial markets was the failure of Lehman Brothers in the US and the near-failure of several other financial institutions in the US and Europe. As confidence in the financial sector weakened, banks became more uncertain about their ability to sustain funding, which in turn made it harder for them to lend to sound borrowers.
This intensified the credit tightening that had already taken place in a number of countries earlier in 2008. While this previous tightening had primarily been evident in the rise in wholesale funding costs, which were passed on to the household and business sectors via higher interest rates, the renewed turmoil saw this trend develop into a sizable tightening in credit availability. At the same time, there was a marked slowing in global economic activity over the period, which negatively impacted investor sentiment in all asset classes.
The December quarter result for the Australian sharemarket (-18%), was the fifth consecutive quarterly decline and the second worst fourth quarter result since 1875. The only larger quarterly decline was after the October 1987 stockmarket crash (-44%) – see chart below. Over the past quarter, the downward pressure in local shares was experienced across the board, with all share sectors recording negative returns. The typically more defensive sectors of utilities (-5%), healthcare (-6%) and telecommunication services (-9%) outperformed the cyclical sectors such as consumer discretionary (-25%), industrials (-21%) and energy (-21%). The results in the Australian sharemarket were similar to those experienced in the global sharemarket, where all sectors and all regions declined (local currency terms).
Importantly, several of the stocks in our global portfolio such as Novartis (+7.3%), Total (4.5%) and Nestlé (+2.9%) continue to perform well. Investors have responded well to the strong balance sheets and higher level of earnings certainty associated with these ‘quality companies’, many of whom have seen, weathered and performed through periods of high market and economic stress such as the Great Depression and the first oil shock.
Meanwhile, diversification into defensive asset sectors has mitigated some of the large declines recorded in growth sectors. In the current economic climate, returns in the cash market were positive, but continue to decline as central banks around the world aggressively cut interest rates. The returns in the cash market were dwarfed by the return in the domestic bond market (+6.3%) as bond yields continued to decline in the wake of declining inflation, lower official interest rates, softening economic growth and heightened risk aversion. The combination of these forces, and several others, has resulted in the riskless 10-year Australian bond yield (currently around 4.2%) trading at its lowest level since the early 1950s.