It’s been an interesting period for risk assets over the past six months. The last quarter of 2018 saw markets retract as sentiment shifted away from risk assets, driven by fears of further rate rises in the US and a pullback in global growth. Roll forward to the March quarter of 2019 and it has been risk on for equities, with both Australian and global markets posting double-digit returns for the quarter.
Interest rate markets adjusted their expectations, implying that rates may even drop by the end of 2020. It highlights the significant influence the Fed has on market sentiment despite market fundamentals not materially changing. For some time we have been communicating that we are in the later stages of the cycle. The latest recovery may well be a late-cycle market rally, but either way the extended tail of the cycle is still wagging.
Our medium-term view remains that returns will be lower as markets become increasingly constrained by the late stage of the cycle and tighter liquidity. We also believe that market volatility will increase and that valuation opportunities will present themselves as some markets retract. A good example of this has been emerging market equities, where valuation support has been increasing for the sector following a pullback during 2018.
After rising 10.1% over January and February, the S&P/ASX 200 Index paused in March, returning 0.7% before regaining momentum in the first week of April. Over the past year, the ASX has delivered a total return of 12.1%, driven predominately by the 50 largest shares, while the small cap index has returned only 5.8%.
Outside of real estate, the top performing sector in March was Communications (+4.0%), with gains from Telstra (+6.1%) and TPG (+4.4%), which is still awaiting the ACCC’s approval for its Vodafone merger despite announcing its plans in August last year. The Consumer Staples sector (+3.9%) also did well over the month, with Bellamy’s (+36.2%) rocketing higher despite no significant announcements. Investors are possibly anticipating its SAMR accreditation which is required to sell Chinese-labelled products within mainland China.
The two major supermarkets Coles (+4.6%) and Woolworths (+6.0%) recovered from a disappointing earnings season, while GrainCorp (-5.9%) was lower through March but sprung back in early April as it announced the demerger of its global malting business. Energy (-4.1%) was the worst performing sector as investors were spooked by news of Chinese pushback against Australian coal, with New Hope Corp (-28.3%) suffering a large drop as minority shareholders pulled out.
Global shares remained buoyant in March but appeared to run out of steam after rallying hard through the start of the year. After spiking to 36 points in December, the VIX has moderated as markets have pushed higher, ending March at around 13 points.
The US S&P 500 Index rose 1.9% through the month in US dollar terms, led by the IT sector (+4.8%) and in particular Apple (+9.7%). Investors are seeing upside in the company’s services and wearables segments as iPhone revenue heads south. The STOXX Europe 600 Index rose 1.7% in March but was weighed down by the banking (-4.4%) and auto (- 2.8%) sectors. After intense speculation, Germany’s two biggest banks, Deutsche Bank (-11.0%) and Commerzbank (-4.9%), finally announced that they are actively considering a merger. The ECB’s banking supervision board stated there would likely be significant conditions attached, while unions fear up to 30,000 jobs could be cut as a result.
The UK’s FTSE 100 Index rose 3.3% in March as British MPs voiced their opposition to a no-deal Brexit and investors were hopeful a bi-partisan deal could be reached. In Asia, China’s markets continued to rally strongly through March on the back of stimulus announcements and progress in trade talks, with the CSI 300 rising 5.5% in March and 28.7% over the quarter.
While equity markets stabilised, bond markets sounded alarms for investors as rapid falls in long-term yields resulted in an inverted yield curve (historically a signal that a recession is on the way). The US 10-year Treasury yield fell from 2.72% to 2.41% over March, while the spread between the 10-year and 2-year yields fell as low as 11.8 basis points.
In Australia it was a similar story, with the 10-year yield dropping from 2.10% to 1.77%, a decline of nearly 60 basis points since the start of 2019. Global bonds, measured by the Bloomberg Barclays Global Aggregate Index, returned 1.7% over March in Australian dollar hedged terms, while Australian bonds returned 1.8%.
The majority of US Fed members believe the funds rate should remain where it is at a target range of 2.25–2.50% for the rest of 2019, compared to the previous quarter when only two members saw rates staying where they were. Looking forward to 2020, most members believe rates should rise by at least 25 basis points, but members are significantly more dovish compared to the previous quarter. In the UK, the 10-year Gilt yield fell from 1.30% to just below 1.00%, reflecting the global fall in rates as well as potential Brexit anxiety. In Japan, bond buying forced the 10-year yield from -0.02% to -0.09% as investors took cover from dimming global growth prospects.
Australian listed property left other sectors in its wake in March with the S&P/ASX 200 A-REIT Index returning 6.2% with broad gains across the board. As the recovery in equities took some time out in March, the search for safe-haven assets continued, with investors attracted to the promising outlook for earnings and distributions in the A-REIT sector.
Generally, debt levels are seen as sustainable and investors have even enjoyed a rise in Net Tangible Assets (NTAs) in recent months, especially in industrial and office assets, although retail still faces some significant headwinds. Diversified manager Charter Hall (+16.7%) was ahead of the pack in March, flagging a $100 million investment in Australian early learning centres. Stockland (+10.0%) was another solid gainer, making further progress on its non-core retail divestment strategy with the divestment of two major centres for $143 million. Shopping centres also fared well during the month, with gains from Shopping Centres Australasia (+9.5%) and Scentre Group (+6.2%). Globally, developed market REITs rose 3.8% in AUD hedged terms.
In the US, REITs also experienced solid gains, returning 3.6% in US dollar terms, with gains from Diversified (+7.1%), Single Tenant (+5.5%) and Manufactured Homes (+4.7%), and falls from Hotels (-1.7%).
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.