Cash

The Reserve Bank of Australia (RBA) left the cash rate unchanged at 6.0% during the month. The UBS Bank Bill Index returned 0.5% for the month.

At the time of writing the RBA had lifted the cash target rate to 6.25%.

Australian bonds

The UBSA Composite Bond (All Maturities) Index returned -0.2%, underperforming the UBSA Bank Bill Index (+0.5%). Yields rose across all maturities in October as inflation figures released during the month signaled a rate rise in early November, which occurred at the time of writing. The market is now pricing a high probability of an additional rate rise early in the New Year.

Against the backdrop of rising inflation, macro-economic data was largely positive. The Melbourne Institute Consumer Confidence Index rose to 105.2 (+3.9% month-on-month), a reading above 100 indicates that optimists outnumber pessimists. Data released during the month showed that Australian employment rose six times more than expected in September. The economy has created 258,000 jobs this year, reflecting the strength of corporate Australia but exacerbating the shortage of skilled workers leading to inflationary pressures in the labour market.

The 3-Year and 10-Year bond yields ended the month at 6.0% (+18bps) and 5.7% (+15bps) respectively.

International Bonds

The Lehman Global Aggregate Index (hedged, A$) returned 0.6%, outperforming the Australian fixed interest market (-0.2%).

US Federal Reserve Chairman, Ben Bernanke, indicated that a "substantial correction" in the US housing market was slowing the US economy. This led Goldman Sachs and AllianceBernstein to downgrade their forecasts on US economic growth for 2006 to 2.0%. The US 3-Year and 10-Year bond yields ended the month flat at 4.6% and 4.6% (+3bps) respectively.

In Europe, fixed interest markets moved higher as ECB President, Jean Claude Trichet, signalled a likely increase in rates before the end of the year. ECB Council Member, Nout Wellink, noted that interest rates remain "very low" and that inflationary pressures remain on the upside. European 3-Year and 10-Year bond yields ended the month at 3.6% (+5bps) and 3.7% (+4bps) respectively.

In Japan, inflation unexpectedly slowed, making the probability of a rate increase less likely this year. While consumer prices remain stable, producer prices advanced by the most in 25 years. This increased the pressure on companies to pass on their higher costs to consumers to protect profits with the inflationary effect likely to be felt in the New Year. Employment data was positive, during the month, with the unemployment rate holding at near an eight year low (4.1%), signalling that wages may rise and drive a recovery in consumer spending in the medium-term. Japanese 3-Year and 10-Year bond yields ended the month at 0.9% (+9bps) and 1.7% (+7bps) respectively.

Australian Listed Property Securities

The S&P/ASX 300 Property Accumulation Index returned 0.9% for the month, underperforming the boarder Australian share market. However over six months (+12.0%), 1 year (+2.8%), 5 years (+1.6%) and 10 years (+1.7%) property trusts have significantly outperformed Australian shares.

The best performing sectors were Diversified (+2.7%) and Industrial (+1.1%). The worst performing sectors were Retail (-0.2%) and Office (-0.1%). The best performing stock was Grand Hotel Group (+15.7%) as the company resolved the takeover from Malaysian property company Mulpha. Centro Properties (+5.2%) also recorded strong performance following the A$4.3 billion acquisition of the US based Heritage Property.

The sector is offering a forward yield of 6.2%, a discount (0.2%) to the 3-Year bond and slight premium (+0.5%) to the 10-Year bond yields. The forward yield premium is below historical averages of 1.8% (3-Yr) and 1.7% (10-Yr). The market is currently pricing the sector based on growth opportunities rather than historical valuation metrics.

International Listed Property Securities

The UBS Global Investors Hedged Index (+4.6%) significantly outperformed Australian listed property (+0.9%). The best performing markets were North America (+6.0%), and the UK (+6.0%). All regions recorded positive performance with the exception of Hong Kong (-2.6%).

German REIT legislation released during the month was less positive than hoped, with residential property excluded from the legislative framework. The legislation will enable a new flow of properties to come to market, providing significant scope for global managers with skill to identify the right investment opportunities.

Australian Shares

The S&P/ASX 300 Accumulation Index returned 4.7% for the month. The drivers over the month were stock specific, rather than style orientated, with the indices for growth (Macquarie Growth: +5.0%) and value (Macquarie Value: +4.6%) performing roughly in line.

The best performing sectors were Materials (+9.5%), Telecommunications (+6.7%) and Consumer Discretionary (+6.6%). The worst performing sectors were Consumer Staples (-0.7%), Utilities (-0.1%) and Energy (+0.7%).

Merger and Acquisition (M&A) activity continued unabated in October with the Media sector dominating, following changes to the regulatory framework. APN News & Media received an approach from Irish based company, Independent News & Media. PBL transferred its core media assets into a new company PBL Media, which would be owned jointly by PBL and private equity group CVC Capital. News Corporation and Seven Network both acquired minority stakes in print media companies - Fairfax (7.5%) and West Australian Newspaper Holdings (14.9%) respectively.

The market crested new highs during the month. While the price to earnings ratio of the market remains around its historical average, the key risk moving forward is that the earnings assumptions underlying this multiple proves too optimistic. This risk was evident during the month with profit warnings from Boral, Futuris, Graincorp and Sky City Entertainment.

International Shares

The MSCI World Ex Australia Index (net div) in $A hedged returned 3.1% in October, significantly outperforming the unhedged return as the Australian dollar rallied against all major currencies. The Australian dollar rose against the US Dollar (+3.6%), Euro (+2.9%), Japanese Yen (+2.8%), and UK Pound (+1.5%).

The best performing sectors were - Materials (+5.7%), Telecommunications (+5.5%), and Consumer Discretionary (+4.8%). The worst performing sectors were Health Care (+0.4%) and Consumer Staples (+1.1%).

US (S&P 500: +3.2%) delivered a strong return against the backdrop of a slowing domestic housing market and weaker results from the service sector. The third quarter reporting season continued to record double digit profit growth, exceeding market consensus forecasts. The standout performers were Genentech (profit: +58%); Merrill Lynch (profit: +41%), and Microsoft (profit: +11%).

Europe (MSCI Europe: +2.9%) registered solid performance. The best performing markets were Germany (DAX: +4.4%) and the UK (FTSE: +2.8%). Germany's industrial production increased by the most in three years in August, with the government raising economic growth forecasts for 2007. ECB President, Trichet, noted that the outlook for Europe remained positive with the economy "broadening" and the prospects for economic growth "more sustained".

The Japanese equity market (Nikkei 225: +1.7%) delivered a return below global peers. Economic growth remains robust. The current economic growth cycle which began in February 2002, is set to surpass the "Izangi boom" (1965-1970) and become the longest economic expansion since WWII. During the month, the Tankan business confidence survey unexpectedly rose to a two year high. The largest increase in confidence was amongst export orientated manufacturers who continued to benefit from weakness in the Yen.

Global Emerging Markets

The MSCI EM in $A (with div reinvested) Index returned 1.0%. The best performing regions (in local currency) were Latin America and BRIC (Brazil, Russia, India and China).