Cash

The Reserve Bank of Australia (RBA) left the cash rate unchanged at 5.75% 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 6.0%.

Australian Bonds

The UBSA Composite Bond (All Maturities) Index returned 0.1%, underperforming the UBSA Bank Bill Index (+0.5%). Yields rose across all maturities as inflation tracked higher and the market anticipated a rate rise in early August.

Deputy Governor, Glen Stevens, noted that the May 2006 rate rise (+25bps) "didn't have as big an effect as the increased rate in March 2005". This raised fears that additional rate rises would be required to contain inflation.

Whilst bonds rallied in international markets, the Australian bond market did not follow the global trend, reflecting higher inflationary pressures in the domestic market. The strength of the global economy will largely determine whether further rate rises in Australia tip the domestic economy into a slowdown or act as a constraint on growing inflation pressures.

The 3-Year and 10-Year bond yields ended the month at 6.0% (+18bps) and 5.8% (+6bps) respectively.

International Bonds

The Lehman Global Aggregate Index (hedged, A$) returned 1.2%, its best month since August 2004. Yields retreated across all major markets as inflation fears moderated.

US Federal Reserve Chairman Ben Bernanke indicated that the "anticipated moderation in economic growth now seems to be under way". Economic data released during the month reinforced this picture, with slower GDP growth (2.5% annualised, consensus: 3.0%) and the weaker employment data (June: +121k, consensus: +175k). Slower economic growth and weaker labour markets will place a ceiling on any further rate rises. US 3-Year and 10-Year bond yields ended the month at 4.9% (-21bps) and 5.0% (-16bps) respectively.

In Europe, fixed interest markets moved higher. European Business and Consumer Confidence rose to a five year high in June, and the European Union indicated that economic growth in the region would accelerate in the fourth quarter. European 3-Year and 10-Year bond yields ended the month at 3.6% (-10bps) and 3.9% (-15bps) respectively.

In Japan, yields were flat over the month as the Bank of Japan raised rates to 0.25% heralding the end of deflation as CPI rose by the most in eight years. The government raised the GDP growth estimate for the year ending March 2006 to 2.1%, and the unemployment rate fell to an eight year low. Japanese 3-Year and 10-Year bond yields ended the month at 1.0% (+3bps) and 1.9% (0bps) respectively.

PIMCO's Bill Gross, manager of the world's largest bond fund, stated during the month that "the bond bear market is beginning to go into hibernation, which is the same thing as saying the bear market is over".

Australian Listed Property Securities

The S&P/ASX 300 Property Accumulation Index returned 2.6% for the month. Australian listed property trusts outperformed the broader share market for the third month in succession since the RBA raised interest rates in early May. For the three months to 31 July, Australian property has outperformed the broader share market by 8.1%.

The best performing sectors were Retail (+4.6%) and Diversified (+1.6%). The worst performing sectors were Office (+1.1%) and Industrial (-1.0%).

Retail outperformed, driven by a strong rise in Westfield. Troubled Multiplex also performed strongly over the month following several pieces of good news that included a positive dividend per share announcement, expected upward asset re-valuation and continued strong performance in its funds management business.

International Listed Property Securities

The UBS Global Investors Hedged Index (+3.8%) was the best performing asset class over the month.

The picture was the same as Australia with most property markets outperforming their respective broader share markets. The best performing markets were the UK (+7.1%), Continental Europe (+5.0%) and Hong Kong (+4.4%). The worst performing market was Japan (-1.4%).

Merger & Acquisition (M&A) activity continued to dominate the European markets with Fonciere des Regions and Bail Investissement agreeing to merge to become France's fourth largest real estate company. In the US, Kimco Realty agreed to buy Pan Pacific Retail Properties ($2.9b). The German market was buoyed by further move toward the introduction of the German REIT structure that aims to be effective 1 January 2007.

Australian Shares

The S&P/ASX 300 Accumulation Index returned -1.7% for the month. Despite higher Consumer Confidence and falling unemployment, the share market was driven lower by strong inflation data and the anticipation of higher interest rates.

The best performing sectors were the defensive sectors of the market. These sectors were Utilities (+3.5%), Telecom Services (+3.1%) and Property Trusts (+2.6%). The worst performing sectors were Materials (-5.0%), as commodity prices moderated on weaker global growth, and Health Care (-3.7%).

Strong company profits continued to underpin the performance of the market. The best performing companies were Caltex (profit: +14%) on higher refining margins; ASX (profit: +25%) on higher trading revenues; CSR (profit: +10%) as sugar prices continue to appreciate; and Woolworths who upgraded profit on significantly improved fourth quarter sales (sales: +23%).

M&A activity continued. AP Moeller bid for Adsteam Marine ($693m); Macquarie purchased Duquesne Light ($1.6b); ABC Learning bought Hutchisons Child Care Service ($70m); and private equity group ARH bid for Colorado Group ($125m).

The market continued to wrestle with an uncertain outlook, trying to balance the likely directions of inflation, interest rates and growth and their potential impact upon companies. It was a month that saw value stocks outperform growth. The more volatile and momentum stocks underperformed as investors sought stocks with more predictable future earnings streams and more defensive characteristics.

International Shares

The MSCI World Ex Australia Index (net div) in $A hedged returned 0.6% in July.

While equity markets edged up in July, unhedged Australian investors (-2.6%) suffered. The Australian dollar rallied against the major currencies as investors factored in higher interest rates. The Australian dollar rose against the Euro (+3.3%), Japanese Yen (3.3%), US dollar (+3.1%) and the UK pound (+2.2%).

The best performing sectors were - Health Care (+3.7%), Utilities (+3.4%) and Energy (+3.3%). The worst performing sectors were Industrials (-3.6%) and Information Technology (-3.5%).

US (S&P 500: +0.5%) delivered a modest return against the backdrop of slowing economic growth. Corporate profitability remained strong with pharmaceutical companies Genentech (profit: +79%), and Johnson & Johnson (profit: +9%) delivering impressive results. In second quarter reporting, the average increase in profits was 19.4% with 423 of S&P500 companies having reported at the time of writing.

Europe (MSCI Europe: +1.3%) registered strong performance. The best performing markets were the UK (FTSE: +1.6%) and France (CAC: +0.9%). M&A activity moderated over the month, as companies considered the impact of higher interest rates on financing costs. Corporate profits remained robust with Nokia (profit: +43%) and BP (profit: +30%) the best performers.

The Japanese equity market declined (Nikkei 225: -0.3%) as moderating US growth weighed on exporters. Consumer Confidence fell more than expected in June as the Nikkei 225 sank to a seven month low and rising fuel prices eroded spending power. While consumers were weaker, Business Confidence rose as corporate spending increased. Japan's largest companies plan to increase investment at the fastest pace in 16 years. Japanese bank lending rose by the most in a decade, further reflecting the stronger corporate environment.

Global Emerging Markets

The MSCI EM in $A (with div reinvested) Index returned -1.7%. The best performing regions were BRIC (Brazil, Russia, India and China) and Emerging Asia.