The third quarter of 2011 was one of the worst since the GFC and has thrown up some major challenges for investors.
The primary drivers have been the eurozone sovereign debt crisis, the US economy downgrade and the Chinese government slamming on the brakes in an attempt to engineer a soft landing for their economy. These factors have combined to cause some major volatility throughout the quarter.
Global Roundup
The devastating European sovereign debt crisis, triggered by the PIIGS economies, has driven European leaders to develop the European Financial Stability Facility (EFSF) bailout fund. The ESFS requires approval from all 17 nations in the eurozone, however this coordination has taken considerable time and has meant that the size of the fund is substantially below what analysts suggest is required to repair the region’s financial system. Many European banks are facing financial ruin at this point, and the IMF said this week that the eurozone is potentially facing a double-dip recession in 2012.
Commodities prices soared at the start of the quarter, particularly for the precious metals. However they have crumbled in the past month, similar to what happened in the GFC of 2008 when investors attempted to reduce risk in their portfolios by liquidating positions and moving to cash.
Investors have been focusing on the contracting global growth, the eurozone debt crisis, and the stand-off which played out in the US over increasing their debt ceiling. All these factors troubled the markets and even led to a downgrade of the US for the first time in history.
The Chinese market has lost -13% and the US markets were down over 14% for the quarter. The S&P ASX 200 has underperformed both, plunging -17% in the quarter, though it has recovered 2.5% so far this week.
Another key issue for local investors this quarter has been the Aussie dollar, which surged to post-float highs of $US1.1079 – the highest level for 29 years. The dollar has now turned around sharply, inline with the sell-off in commodities and is now trading well below US dollar parity. Local exporters are breathing a sigh of relief after being trashed for most of this year.
Looking ahead the key driver for the global markets this quarter will be the reaction of investors to the effectiveness of the EFSF bailout, as European leaders move to address the sovereign debt crisis and the consequent problems with the eurozone financial system.
In Australia the RBA is expected to leave rates on hold for the near-term, with a bias towards easing as we move into the end of the year, and we had better-than-expected retail sales figures this week.
In the commodities space prices have undergone a rollercoaster ride, with strength at the start of the quarter followed by a trashing in the final month of the period.
Gold has been the strongest performer surging to all-time highs of $US1,910, but it has since plummeted to around $US1,600. Copper, which is a true barometer of global economic activity, has spent most of the quarter trading lower and is down over -30% from its quarterly highs. Crude-oil continues to trade in a downtrend and is down over -18% for the quarter.
The news is pointing towards a global economic slowdown, and if the European leaders fail in their quest to bailout the PIIGS economies, we could be in for a downturn that surpasses the GFC. The US economy is trying to get some traction though and their markets are currently at key support levels. The Chinese market has been in a downtrend since April this year.
Australia
The Aussie market has underperformed the US and Chinese markets, but all markets have traded down significantly in the past quarter. The Telecom sector is the only one to have produced positive returns in the past quarter and is also the only sector to be in the green for the year.
We have taken this opportunity to review the Australian share market’s quarterly performance on a sector-by-sector basis, as illustrated below:
Chart: ASX market performance to date by sector for the quarter starting 1 July 2011.
Year-on-Year Performance
The year-to-year rolling performance (YoY, as shown by the black bars) has been negative for all sectors except Telecommunications. The chart illustrates how tough the last 12 months have been for all other sectors: we can see that the Telecommunications sector has shown strength for the year (up 16.7 percent YoY), with all other sectors performing dismally. The worst performers have been the Consumer Discretionary sector (down -22%), the Info Tech sector (down -19%) and the Energy sector (down -17%), while the Industrials, Materials and Financials sectors are all down over -13% for the year. Consumer Staples and Health Care are down -7%, while the Utilities sector has relatively outperformed and is down only -4% for the year.
Monthly Performance
We have seen the market volatility spike over the past couple of months which culminated in the “flash crash” in August. September saw a retest of the August lows. October has started off positively, but there are still concerns over the sovereign debt crisis in Europe which needs to be addressed near-term.
The performance for the month of September (as shown by the green bars), has been diabolical, with the exception of the Telecom and Consumer Staples sectors which have managed to eke out gains of only 1.2 percent, while Health Care was down only -2% for the month. The Utilities, Industrials, and Financials sectors were all down over -5% for the month. The worst monthly performers included Energy (down -8%) and Materials (down nearly -14 percent), due to the plunging commodity prices over the past month.
Quarterly Performance for 2011_Q3
The quarterly performance (QTR, as shown by the blue bars), has also been dismal with the exception of the Telecommunications sector. The defensive sectors have relatively outperformed with the Utilities and Health Care sectors down only -2% and -4% respectively. All the other sectors have plunged over -11% for the quarter, with the worst performer being the Materials sector down over -19%.
The market correlation across all sectors has been uniform, with all sectors being trashed for the quarter. There has been nowhere to hide in this market (except for Telstra), but if the Europeans get their act together with the EFSF bailout, we could be setting up for a rally into the end of the year. Those subscribers who follow the recommendations of MDS Financial Research get timely recommendations, as individual stocks start to move.
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In summary the Telecommunications sector is the only sector that has consistently outperformed for the year, and there has been a clear dumping of materials, energy and financials stocks. Interest rates are unlikely to rise and the Aussie dollar is likely to remain below parity in the medium-term.
Given the sector performances over the past quarter and year-on-year, there are a number of strategies traders and investors can use, including relative strength comparisons or mean reversion.
1. Investors who use relative strength comparisons and look to trade strong stocks in strong sectors can only trade the Telecommunications Sector (Telstra, that is), for trading into Q4 of 2011, which is very limiting. Using relative strength we would expect the Energy, Materials, Financials and Consumer Discretionary sectors to continue to under-perform.
2. Investors who use a mean reversion strategy may want to concentrate on Energy, Materials, Financials and Consumer Discretionary, which have been underperforming the broader market. For a margin of safety look to stocks that are paying consistent dividends and have balance sheets that are conservatively geared.
The investment themes that could trigger a rebound in this quarter are:
* economic recovery in the eurozone
* a recovery in commodity prices
* the Aussie dollar to remain below parity
* corporate earnings to improve
* interest rates and inflation to hold or drift lower
* continuing M&A activity
Note: ASX_200 [.AXJO] Energy [.AXEJ], Materials [.AXMJ], Financials [.AXFJ], Utilities [.AXUJ], Discretionay [.AXDJ], Staples [.AXSJ] and Healthcare [.AXHJ]
Codes in brackets are for use in the Market Analyser software. Use these codes to review indices, and drill down to examine the stocks within. If you are not a Market Analyser user, sign up now for a free software trial.
Stay tuned for further analysis of the quarterly performance, as next time we will examine the Australian market performance with stocks broken down by market capitalisation.
By Michael Hevern
Head of Research
