Cash

The Reserve Bank of Australia (RBA) left the cash rate unchanged at 5.5% during the month. Interest rates have been “on hold” since March 2005, when they were increased to the current level.

Australian Bonds

The UBSA Composite Bond Index (All Maturities) returned 0.1%, significantly underperforming the UBSA Bank Bill Index (+0.5%), as yields rose across all maturities. The 10-Year and 3-Year yields ended the month at 5.4% (+12bps) and 5.3% (+6bps) respectively.

RBA Governor Ian MacFarlane noted that given the lower than expected real GDP figure of 0.5% in the fourth quarter “we should expect to see annual real GDP growth rates mainly in the 2s and 3s, rather than in the 3s and 4s”. Recent quarters have seen a transition from consumer-led investment demand to business-led investment demand (+18% yoy) as the housing market has slowed. Businesses are operating at their highest level of capacity utilisation since the late 1980s. Yet this is unlikely to fuel significantly higher inflation as increasing capacity and (historically) cheap financing are moderating the rising cost of materials and labour.

The outlook for Australian fixed interest markets remains benign with inflation expected to stay within the RBA target range of 2-3%. With both 3 Year and 10 Year bonds trading below the target cash rate (5.5%) investors are not being compensated for longer duration investments.

International Bonds

The Lehman Global Aggregate Index (hedged, A$) returned -0.9%, its worst performance since April 2004, as bond yields advanced on positive economic news and the threat of rising inflation.

The US economy grew at 1.7% (annualised) in the fourth quarter, as inventory investment and personal consumption buoyed the economy. Core consumer inflation (+2.4% annualised) rose at a faster pace than expected, fuelling fears that the Federal Reserve may need to continue raising rates. This sent bond yields higher. US 3 Year and 10 Year bond yields ended the month at 4.8% (+20bp) and 4.9% (+30bp) respectively.

In Europe, Consumer Confidence reached a 15 year high, prompting fears that the European Central Bank may target higher interest rates. European 3 Year and 10 Year bond yields ended the month at 3.4% (+33bp) and 3.7% (+28bp) respectively. One symptom of the frenetic M&A activity in Europe, which has driven equity markets higher, has been the widening of corporate credit spreads. This has created greater volatility in corporate debt markets.

In Japan, bond yields were pushed higher as consumer prices rose at the fastest level in eight years and wage growth continued its longest expansion since 1997. Japanese 3 Year and 10 Year bond yields ended the month at 0.8% (+19bp) and 1.7% (+15bp) respectively. The BoJ announced mid month that they were ending the policy of flooding the economy with ‘cheap money’, affirming the BoJ’s view that the threat of ongoing deflation is reduced.

Bond investors appear to be accepting that the positive global economic conditions may result in marginally higher near term (and longer term) inflation expectations than they had previously priced in.

Australian Listed Property Securities

The S&P/ASX 300 Property Accumulation Index (-0.4%) underperformed the broader Australian equity market in March, as investors showed a preference for cyclical stocks. For the calendar year-to-date, the property sector trailed the equity market by 7.3%.

The best performing sectors were Office (+4.2%) and Diversified (+1.2%). The worst performing sector was Retail (-3.0%) impacted by the poor performance of Centro Properties (-4.9%) and Westfield Group (-3.0%). The best performing stocks were Reckson New York (+14.6%) on the back of improving fundamentals, and Babcock and Brown Japan Trust (+6.4%) which continued to experience strong support as the Japanese economy recovers.

Whilst the Australian listed property market does not appear overly stretched, valuations appear more compelling internationally. This was evidenced in March by the strong performance of Australian listed, but internationally focused, trusts.

International Listed Property Securities

The UBS Global Investors hedged Index (+4.5%) performed strongly. The best performing markets were North America (+5.1%), Europe (+5.0%) and Hong Kong (4.9%). The worst performing markets were Australia (-0.4%) and Japan (+2.6%). Investors are pricing significant growth opportunities with most markets trading at a premium-to-net-tangible assets – Singapore (+64.2%), Japan (+58.3%), Australia (+45.7%), Continental Europe (+31.9%), US (+25.6%) and the UK (+13.1%). The only market trading at a discount to-net-tangible assets is Hong Kong (-5.4%).

Australian Shares

The S&P/ASX 300 Accumulation Index (+4.8%) performed strongly as rising commodity prices and M&A activity boosted the market. Australian shares had their best first quarter in 15 years, as the All Ordinaries Index passed 5000.

The best performing sectors were Materials (+12.4%) and Energy (+10.4%). The best performing stocks were Material stocks - Oxiana (+40.7%), Lihir (+25.4%) and Zinifex (24.6%). The worst performing sector was Telecommunications (-2.4%) as investors sold down Telstra (-2.8%) on concerns over sustainability of future earnings.

M&A in the first quarter reached 2001 levels with $30 billion of deals announced. Toll (+12.2%) re-launched its hostile takeover offer for Patrick Corporation (+17.6%). The Australian Stock Exchange (+0.7%) announced a friendly merger with the Sydney Futures Exchange (+27.5%), creating the ninth largest listed exchange group in the world. Tattersalls (+9.2%) and UNiTAB (+10.3%) announced merger plans, and Transpacific Industries (+50.7%) announced its intention to merge with Waste Management NZ.

Soaring earnings growth has left companies awash with cash. Combined with low interest rates and large private equity reserves, there is a considerable amount of liquidity. This environment provides a solid footing to bid share prices up. Looking forward, this can create opportunities for well researched stock selection.

International Shares

The MSCI World Ex Australia Index (net div) in $A unhedged (+6.5%) significantly outperformed the hedged return (+2.7%) as the Australian dollar declined against the Euro (-5.4%), US dollar (-4.0%), UK pound (-3.1%) and Japanese Yen (-2.2%). Strong commodity prices led the MSCI Growth Index (+10.5%), to outperform the MSCI Value Index (5.5%).

US (S&P 500: +1.1%) stocks performed well as the Consumer Confidence Index rose to the highest level in four years. US companies rounded off a tremendous reporting season with profits up 16% (yoy). The US market continued to under-perform regional Asian and European markets, in part due to higher valuations, yet also because of fears about the US housing ‘bubble’. Similar to the UK and Australia the US has witnessed significant appreciation in house prices, leading to a ‘net-wealth effect’, where investors’ unlocked equity from their home to purchase discretionary items. With the deflating of this ‘bubble’, as witnessed in March with new home sales falling by the most in nine years, there remains concern whether the US economy will successfully transition from consumer-led economic growth towards business-led economic growth.

Europe (MSCI Europe: +2.7%) performed strongly on continued M&A activity and positive economic growth. The best performing markets were France (CAC: +4.4%), Germany (DAX: +3.0%) and the UK (+3.0%), with weaker performance from Italy (+0.9%) despite Italian business confidence rising to a five year high in March. European markets continue to trade at a price-to-earnings discount (MSCI Europe: 15.2x) to the US (S&P500: 18.3x).

Japan (Nikkei 225: 5.3%) once again was the standout performer as positive economic data filtered through to equity markets. Japanese small business confidence rose to its highest level in 15 years and the jobless rate fell to its lowest level in seven years.

Global Emerging Markets

The MSCI EM in $A (with div reinvested) returned 5.1%. The best performing region was Emerging Asia and BRIC (Brazil, Russia, India and China).