Where were we this time last year?

However, to understand precisely what evolved, he says you have to look at the factors that affected the markets at the start of the last financial year.

Where were we this time last year?

The international economic outlook was strong. Above trend global growth of 4.5 per cent was forecast by the International Monetary Fund, and, with signs of US growth deceleration, the composition of growth was appearing to even out.

Signs were emerging that consumer spending and housing credit were easing. An increase in exports due to rising commodity prices, and recovery in farm output following the drought were expected to offset weaker consumer sentiment.

Inflation risk had come to prominence due to higher materials, transport and higher per unit labour costs.

Booming capital expenditure in the private sector, and an overdue public sector response to under-investment in infrastructure boded well for capital spending.

The main concern for the equity market was the profit cycle. Could the good times last?

Factors that could derail optimistic profit expectations included input cost inflation, an unexpected lift in interest rates or a collapse in the property market, with the consequent negative consumption affects due to a reversal in wealth affects.

Fears were also held for consumer sentiment and consumption should interest rates rise unexpectedly in an environment of record indebtedness.

Bottlenecks would likely constrain record productivity growth.

The US Federal Reserve commenced a tightening cycle by raising official rates by 0.25 per cent. The Reserve Bank of Australia adopted a wait and see approach, not raising rates for seven months, with the last moves being increases in both November and December 2003.

The risks though seemed distant. Employment remained strong, housing credit, having fallen sharply, subsequently returned to trend growth.

The domestic economy was set to benefit from the broadening strength in the global economy.

So how did it pan out?

The S&P/ASX200 Accumulation Index rose 26.4 per cent over the year to June 2005.

The economic miracle of China led to significant additional demand for commodities with oil, iron ore, coking coal and copper benefiting the most.

Market valuation rose due to greater earnings and lower interest rates. Commodity suppliers in particular drove earnings. Share buy-backs also helped earnings growth.

Strength of balance sheet, strong cash-flow and capital discipline resulted in buy-backs being a major feature of the year. Buy-backs reduce the number of shares on issue, lifting earnings per share and usually acting as a positive signal.

There were 37 buy-backs announced in the year to June, 13 more than the previous year, with a total value estimated by UBS to be $8.2 billion. Many other firms initiated on-market buy-backs.

Cash based takeovers during the year lifted target prices, and the re-investment of proceeds lifted the broader market. Corporate actions supported the market accelerating value recognition. Successful bids left target company holders with considerable cash.

A Morgan Stanley Capital Index rebalance favoured Australia and added many new stocks that also acted in support of the market, as offshore managers sought exposure to reflect the index changes.

The news flow was not all good. The heavily indebted consumer continued to withdraw. Retail sales have fallen, and widespread discounting to clear inventories will no doubt devastate retailer profit margins.

Cashcard data reflected the drop in consumption, and declining personal credit volumes confirmed that consumers are repaying debt. Building material suppliers faced a slow-down in activity.

Earnings downgrades came through thick and fast during March. Smaller companies and those companies exposed to discretionary consumer spending were well represented among company earnings confessions.

Sectors that contributed most to the benchmark gain were energy, materials, financials ex-property, and industrials. The greatest drag came from automobiles and retail.

An oil price rally to US$60 from US$36 saw markets fall from all-time-highs in June.

Australia is better placed than most nations as a net energy exporter. Despite this, the negative impact of higher oil prices on the US, Europe and Japan will lower global growth and reduce demand for exports.

Long bonds rallied, defying inflationary concerns. The fall in yields and rotation from cyclical to defensive sectors was driven by US growth easing mid-year.

Christmas came early for domestic equity managers in the form of broad gains. The best present for active managers was an increase in the dispersion of returns. After an extended period where returns were historically similar, the shifting macro forces resulted in a welcome increase in cross-sectional volatility.

Mal Whitten is portfolio manager, Tyndall Investment Management.