Equity markets have continued their recovery through February, with the S&P 500 and S&P/ASX 300 both rising 5.2% in Australian dollar terms in the first three weeks of the month. This comes on the back of January’s gains of 4.5% and 2.6% respectively. In price terms, the US index has recovered from a sharp fall in December, while the ASX has clawed back nearly all losses suffered in the final quarter of 2018.
US markets have led the comeback, buoyed by the Federal Reserve’s pivot to a more dovish stance on monetary policy after announcing that it will keep rates on hold until further notice. Over the last 12 months we have also seen an increase in market volatility, with risk measures such as the VIX spiking in December, but volatility has since eased following the Fed’s revised expectations, with the VIX dropping to a four-month low.
Does this mean that we’ve seen an end to volatility? Our view is that volatility will remain at a heightened level – or, arguably, at more normal levels – over the course of 2019. While we may see a pause in rate rises in the US, we continue to believe that we are at the late stage of the cycle. The winding back of central bank liquidity support via quantitative easing, tighter access to credit, and the possible flow on effects of a slow-down in the Australian housing market, remain the key issues for investors, while shorter-term indicators such as price momentum have turned negative.
We are starting to see pockets of value appearing on a sector level. An example of this is within emerging markets, which sold off over 2018 and have since showed signs of stabilising. We are also seeing more investment opportunities on a stock level where the increase in market volatility is providing an opportunity to invest in quality companies at a reasonable price. However, value measures take a long-term view of the market, and assets can remain ‘cheap’ or ‘expensive’ for extended periods, hence it is also important to look at business cycle and other medium-term indicators.
The S&P/ASX 200 Index returned 3.9% in January as stocks recovered from a global selloff in December. In early February markets were able to digest the recommendations of the Royal Commission report into financial services misconduct, which provided a measured response to the system’s failings. Major financial services shares moved higher, but overall the sector remains beaten down having fallen 14.8% over the course of 2018. Energy (+11.5%) was the top performing sector in January, with large gains from Beach Energy (+33.8%), whose December quarter results held up well given seasonally low gas demand, and Worley Parsons (+21.5%), which inched closer to completing its $3.3 billion acquisition of US group Jacobs Engineering. The Information Technology sector (+9.3%) swiftly recouped losses sustained through the December quarter, driven by the major ‘WAAAX’ stocks including AfterPay Touch (28.3%), Appen (+24.4%) and Wisetech Global (+20.4%), which managed to claw back their already dizzying valuations. Communications (+7.9%) posted solid gains, with Telstra (+9.1%) attracting interest despite the risk of a further de-rating if its dividend is cut to 16c per share. The ASX 200 VIX, which measures implied volatility, fell from its recent high of 20.6 in December to end January at 14.1.
Global shares staged a comeback in January with hopes raised for a positive US earnings season and some backtracking from the Federal Reserve on its more hawkish comments. The US S&P 500 Index rallied 8.0% over January in Australian dollar terms and hit a fiveday winning streak in the first week of February. In local currency terms the biggest gains came from Industrials (+11.4%), led by General Electric (+34.2%) and supported by a recovery in major airline shares, which have benefited from concerns over an oversupply of crude oil. Information Technology (+6.9%) shares managed to claw back December’s losses, with Facebook (+26.4%) beating revenue and earnings expectations for the quarter, while Apple (+5.5%) saw modest gains as investors looked beyond declining iPhone sales to strong growth in Apple services and other devices. Markets were mostly muted as President Trump delivered his State of the Union address, while signs of positive developments in the trade negotiations between the US and China helped bring some stability. The UK’s FTSE 100 Index rose 3.6% in January and continued to recover in February as investors remained hopeful that an exit deal will be made in time. Japan’s Nikkei 225 Index rose 3.8% in local currency terms and China’s CSI 300 Index gained 6.3% as Chinese authorities announced further monetary and fiscal stimulus to combat softer GDP.
Fears of a ‘breakout’ in interest rates were allayed in January as slower global growth and softer inflation saw a resurgence in bond values and compression of yields. Global bonds measured by the Barclays Global Aggregate Index returned -2.0% in January in Australian dollar unhedged terms and 1.0% in hedged terms. Major developed market yields have been on a downward path since the end of the September quarter, largely driven by a flight to quality as equity volatility spooked markets and disappointing global data. The impact of the political landscape cannot be ignored either, with continuing tensions around trade policies and the US government shutdown adding to the angst in markets. The US 10-year Treasury yield fell from 2.69% to 2.63% in January, down from its recent highs of over 3.20% in November 2018 as the US Fed sought to reassure markets that it was not blindly committed to its tightening path. Money markets have pared back expectations on the number of rate rises and now expect the Fed to hit the pause button in 2019. Weak inflation figures in Europe saw the German 10-year Bund yield fall from 0.24% to 0.15% while the 5-year yield held at - 0.32%. In Australia, the 10-year yield fell from 2.32% to 2.24%, down from its recent high of 2.76% in November.
The S&P/ASX 200 A-REIT Index returned 6.2% in January as the outlook for interest rate rises softened and bond market yields fell. While Australia offers one of the highest REIT market dividend yields of 5.1%, the spread over 10-year bonds is slipping in comparison to other developed markets. Nevertheless, the 10% fall in the Australian dollar over calendar year 2018 has made prices considerably cheaper to foreign investors. The slowdown in residential markets has been driven in large part by the curtailment of bank lending, while the prospect of a change of federal government (and changes to property and tax regulations) is adding to the uncertainty. In terms of January’s performance, shopping centres were again the laggards, with Shopping Centres Australasia (-2.4%) down ahead of its half-year results, which came in largely as expected, while Vicinity Centres (+0.4%) was flat. Globally, the positive outlook is being underpinned by consistent demand, relatively low vacancy rates, and rental growth that is supporting earnings and dividends. US REITs rebounded from December’s falls, with the biggest gains coming from Warehouses (+15.2%), Shopping Centres (+14.2%) and Offices (+13.9%).
The Australian equity market (as measured by the S&P/ASX 200) started the year off much like the previous finished, although most of the steam had been taken out of the rally with January producing a solid +1.20% return. February was much more muted with the uncertainty of an imminent reporting season hanging over the market however with better-than-expected results, coupled with softer-than-expected domestic inflation data, March provided some highlights as Australian shares hit new record highs. The quarter ended on a high with March producing +3.27% closing the quarter off with an attractive +5.53%.
2023 made for another very interesting year in investment markets as macro / regime driven events resulted in extreme shifts in investor sentiment on an almost monthly basis. Investors chose to shoot first and ask questions later in what can best be described as a year of maximum noise.
The Australian equity market (as measured by the S&P/ASX 200) started the September quarter with a flurry but ended up in the red as the global “higher-for-longer” narrative (interest rates) coupled with the ever-increasing cost of living concerns caused consumer confidence to wane.