Overview
Fixed interest returned 12.40% over the year ending 30 June 2012 while cash returned 4.69%.
Bonds were the best performing asset class over the year. This is because bond prices are inversely related to interest rates so as interest rates fell throughout the year, bond prices rose. The RBA cut rates four times over the year, by 0.25% in November, December and June, and by 0.50% in May.
Conclusion
The June rate cut was followed by a much stronger March quarter GDP announcement than the RBA and markets expected. The June cut probably would not have happened had the Board been privy to that data the day before. This is because while there is undoubted areas of weakness in the domestic economy, that weakness continues to be more than offset by the mining investment boom.
Although the terms of trade have begun to fall as commodity prices ease, the vast pipeline of committed (let alone potential but uncommitted) projects have years to run. Nevertheless, we believe China's slowdown is not so temporary. Not only has China over invested in infrastructure but a not insignificant proportion of which is understood to be unproductive (loss making/operating well below capacity). It follows that fixed asset investment in China can only slow, at which time demand for raw materials (including coal and iron ore) must also slow. This scenario suggests that commodity prices may well continue to fall, necessitating the postponement of further mining projects. If this eventuates, given the already fragile state of the global economy, further interest rate reductions may well eventuate before year's end.
As a consequence we continue to recommend an overweight exposure to cash and a neutral fixed interest exposure.
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