Cash

The UBSA Bank Bill Index returned 0.5% for the month.

The RBA raised the cash rate from 5.50% to 5.75% in early May. The rate rise was widely anticipated by the market. The RBA board noted that "inflationary risks had increased sufficiently to warrant an increase in the cash rate".

Australian Bonds

The UBSA Composite Bond Index (All Maturities) returned 0.4%, marginally underperforming the UBSA Bank Bill Index (+0.5%). The interest rate rise had little impact on fixed interest markets which had anticipated the RBA's move.

Bond yields tracked the swing in risk aversion over the month, with yields rising at the start of the month as share and commodity markets hit new highs. Later in the month, as investors became nervous about inflation and slowing growth, bonds benefited from the flight to safety, and yields dropped accordingly.

Economic data released during the month was mixed. Retail sales figures were higher than expected (April: +1.4%), recording an impressive start to the year (+7.4%). House prices continued to rise, yet declining building approvals (year: -7.5%) demonstrated that some of the froth in the market is dissipating. Business confidence, which had declined in April, rose after the budget announcement, which was viewed as largely positive.

The 3-Year and 10-Year government bond yields ended the month at 5.7% (+6bps) and 5.7% (+3bps) respectively.

International Bonds

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

US CPI rose sharply in April (+ 0.6%), which raised fears of further tightening against a backdrop of softening economic activity. Non-farm payrolls in May rose by 138,000, less than the market estimate (200,000). Retail sales disappointed and consumer sentiment declined sharply. In response to growing inflation the US Federal Reserve raised rates for the 16th consecutive time to 5.0%. US 3-Year and 10-Year government bond yields ended the month at 5.0% (+14bps) and 5.1% (+10bps) respectively.

The European Central Bank (ECB) signalled that it may raise interest rates as early as June as faster economic growth, record oil prices and the growth in (housing) credit are creating inflationary pressures. ECB President Trichet noted that the Bank needed to remain "vigilant" and may raise rates as early as July. European 3-Year and 10-Year government bond yields ended the month at 3.5% (-3bps) and 3.9% (+3bps) respectively.

Japanese bonds tracked sideways during the month. The Bank of Japan's Governor Fukui noted that economic growth has created the platform for rate increases, but the Bank had no "pre-determined plans". Japanese 3-Year and 10-Year government bond yields ended the month at 1.0% (+7bp) and 1.8% (-9bps) respectively.

Australian Listed Property Securities

The S&P/ASX 300 Property Accumulation Index (-1.5%) fell less than the Australian share market in May, as investors shifted away from cyclicals towards defensive stocks.

The best performing sectors were Industrial (+4.2%) and Diversified (-0.9%). The worst performing sectors were Office (-3.3%) and Retail (-2.8%).

The best performing stock was Macquarie Goodman (+7.6%), which raised $350 million during the month to fund the acquisition of a European property developer, which the company expects to increase earnings per share by 8%. Investors continue to reward companies that are assuming development risk and are willing to expand abroad.

International Listed Property Securities

The UBS Global Investors (hedged) Index (-3.1%) fell less than international (hedged) equities     (-4.3%). The sector was weighted down by the prospect of higher borrowing costs and valuation concerns.

The worst performing market was Hong Kong (-8.2%) and Singapore (-6.9%). Both markets have been amongst the best performing this year, up 52.9% and 20.7% respectively. Japan (-1.3%) and Australia (-1.5%).

Australian Shares

May was a month of two parts, in the first two weeks of the month the market rose strongly (+1.8%) before retreating (-6.7%) on higher inflation numbers from the United States. The S&P/ASX 300 Accumulation Index ended the month down 4.7%.

The Federal budget, released during the month, provided some support for share markets with superannuation changes, some infrastructure spending and tax cuts, all positive.

The worst performing sectors were Utilities (-8.9%), Health Care (-8.7%) and Telecommunications (-8.3%). The best performing sectors were Property Trusts (-1.5%) and Consumer Staples (-1.9%).

The best performing stocks were Zinifex (+15.2%) and Babcock & Brown (+9.4%), both of which rose on higher profit guidance. The worst performing stocks were diagnostic imaging business DCA Group (-27.5%) which issued profit guidance below market expectations, and Telecom NZ (-20.3%) after NZ government enabled competition on the company's broadband network.

International Shares

The unhedged MSCI World Ex Australia Index (net div) fell (-2.7%) less than the hedged return    (-4.3%) as the Australian dollar declined against the UK pound (-3.5%), Euro (-2.6%), Japanese Yen (-2.5%), and the US dollar (-0.7%).

US (S&P 500: -3.1%) markets declined on higher inflation fears and further rate hikes. US Consumer Confidence dropped the most since Hurricane Katrina, and US Homebuilder Confidence also declined to an 11 year low as the housing market softened. The market views higher interest rates and weaker consumer spending as likely impact corporate profits.

Europe (MSCI Europe: -5.3%) registered weaker returns as inflation and monetary policy concerns weighed on markets. The declines were uniform across the region - Germany         (DAX: -5.3%), France (CAC:-5.0%) and UK (FSTE 100: -5.0%). Merger and acquisition activity remained strong during the month with NASDAQ gaining large stake in the London Stock Exchange and the NYSE announcing a merger with Euronext the Paris based stock exchange. This has supported the profits of European investments banks which reported during the month   - Credit Suisse (profit: +36%), Deutsche Bank (profit:+55%) and UBS (profit: +33%).

Japan (Nikkei 225: -8.5%) declined as domestic economic growth, while remaining positive, slowed in the first quarter. The impressive performance of Japanese shares over the last year has created some concerns over valuations, these concerns found a catalyst for a correction on the higher inflation and weaker economic data from the US.

Global Emerging Markets

The MSCI EM in $A (with div reinvested) returned -9.9%. For the year to 31 May 2006 the MSCI Emerging Markets index is up 41.2%. The best performing region was the Far East.

Global emerging markets have borne the brunt of the sell off over May, reflecting the sense of risk aversion sweeping across the markets. The declines were fairly uniform across all regions as investors shifted towards more defensive regions and asset classes.