Cash

In April, the Reserve Bank of Australia (RBA) left the cash rate unchanged at 6.25%. The UBS Australia Bank Bill Index returned 0.5% for the month.

Australian bonds

The UBS Australia Composite Bond Index (All Maturities) gained 0.7% as sentiment shifted away from further tightening by the RBA.

The CPI figure for the first quarter (+0.1%), released during the month, was below expectations (+0.6%) and lower than prior quarters. Lower than expected inflation caused a contraction of yields.

The strength of the Australian Dollar was a primary driver of lower inflation with import prices falling 1.7% in the first quarter, after a 3.2% fall in the fourth quarter of 2006.

In the short-term, rates appear to be on hold. However, as witnessed during April, interest rate expectations can change quickly. The focus in the period ahead will be the strength of global and domestic economic growth, and the Federal Budget. Tax cuts may be seen by fixed interest markets, and the RBA, as inflationary.

Australian 3-Year and 10-Year bond yields ended the month at 6.1% (-10bps) and 5.9% (no change) respectively.

International bonds

The Lehman Global Aggregate Index (hedged, A$) returned 0.4% in April.

In the United States (US), the Federal Reserve left interest rates unchanged at 5.25%. At the end of April US 3-Year and 10-Year bond yields were 4.5% (no change) and 4.6% (-2bps) respectively.

US market expectations of rate cuts retreated over the quarter as the market weighed inflationary concerns against slowing economic growth. The chart below shows the market expectations of the Federal Reserve target rate. Market expectations of rate cuts moderated in April with the market anticipating an 11.8% (March: 0.8%) probability of no change in rates, and 53.8% (March: 33.4%) probability of only a modest cut (-25bps) in rates.

In Europe, the European Central Bank (ECB) left interest rates unchanged at 3.75%. ECB President, Jean Claude Trichet, signalled that interest rates would rise in June, following the economy's fastest expansion in six years. European 3-Year and 10-Year bond yields ended the month at 4.1% (+11bps) and 4.2% (+9bps) respectively.

In Japan, the Bank of Japan left interest rates unchanged at 0.5% after consumer prices (April: -0.3%) fell more than anticipated. Japanese 3-Year and 10-Year bond yields ended the month at 1.0% (+6bps) and 1.7% (no change) respectively.

Australian listed property securities

The S&P/ASX 300 Property Accumulation Index returned 3.4% in April. While outperforming Australian shares in April, listed property securities have underperformed the broader market over three (-9.5%) and six months (-2.8%).

Commercial (+6.1%) and Stapled (+3.5%) securities were the best performers, reversing the trend from last month.

International listed property securities

The UBS Global Investors Index (hedged, A$ net dividends) fell -0.6%, outperforming Australian listed property (-4.0%). The best performing market was Japan (+6.2%) which was lifted by rising commercial land values. The only negative performers were North America (-2.6%) and Australia (-4.0%), which together account for two-thirds of the benchmark.

Australian shares

The S&P/ASX 300 Accumulation Index returned 3.0% for the month, its ninth straight monthly gain.

The best performing sector was Financials (+3.7%), as the market expectations of a rate rise moderated. Financials are highly levered to consumer spending and home lending. With rates remaining on hold in the short-term, there was a positive shift in sentiment towards the sector. The worst performing sectors were Information Technology (+0.3%) and Telecommunications (+0.5%).

The troubles associated with US sub-prime mortgages are unlikely to affect the Australian market given the lower exposure of lenders to low quality mortgages.

Merger and Acquisition (M&A) activity continued in April. Coles Group (+7.4%) received a takeover offer from Wesfarmers (+3.7%), which is competing against private equity players. Rinker (+3.1%) accepted a revised takeover bid from Mexican-owned Cemex, four months since the initial bid was rejected.

Some market participants are concerned that private equity investment is eroding the breadth of the Australian market by taking public companies private. In April it was announced that Myer stores (which are private equity owned) may be refloated onto the market within the next two years after the operating profit increased by 84%.

This highlights the potential for companies to come back to the market as private equity owners look to get a return on their investments.

International shares

The MSCI World Ex Australia Index (hedged, A$ net dividends) rose 3.6%, outperforming the unhedged index (+1.3%). The Australian Dollar rose against the Japanese Yen (+4.1%), US Dollar (+2.7%), and the Euro (0.5%).

The US market (S&P 500: +4.3%) was driven by continued strong earnings, with 67.5% of S&P 500 companies reporting positive earning surprises (313 reported by month end). This is compared to 60.9% of companies reporting earning surprises in the fourth quarter 2006 and 73.0% in the third quarter. In addition, the number of negative earnings surprises is higher compared to the first three quarters of 2006. As economic conditions become more challenging there is potential for greater distinction between good and poor performing companies.

Earnings per share for the first quarter of 2007 were 12.4% compared to expectations of 8.2%. Positive earnings momentum helped propel the Dow Jones Industrial average to record highs during April.

Europe (MSCI Europe: 3.6%) delivered solid performance. The best performing major markets were Germany (DAX: +7.1%) and France (CAC: +5.8%), while the UK  (FTSE 100: 2.2%) lagged after an unexpected rise in inflation.

The Japanese equity market (TOPIX: -0.7%) struggled due to sluggish domestic consumer spending which dampened the outlook for the economy.

Global emerging markets

The MSCI EM (in A$ with div reinvested) Index returned 1.5%. Political tensions in Turkey saw the market up 3.0%, after falling around 7% in the three days prior to month end. This experience highlights the political risks in some emerging markets. These risks in the current environment appear to be understated by some non-dedicated global emerging market managers.