The Australian equity market (as measured by the S&P/ASX 200) bounced back from a difficult start to the period (-6.4% in January) to post a positive return (+0.74%) for the quarter. The March quarter was dominated by the outbreak of war in Ukraine which caused massive volatility in growth assets and the final realisation that inflation will not be “transitory”. The fall-out of war coupled with increasing inflationary pressures, China growth concerns and the rather strong February reporting season resulted in a very uncertain period, filled with questions, and one which made portfolio positioning challenging.
The Australian equity market (as measured by the S&P/ASX 200) bounced back from a difficult start to the period (-6.4% in January) to post a positive return (+0.74%) for the quarter. The March quarter was dominated by the outbreak of war in Ukraine which caused massive volatility in growth assets and the final realisation that inflation will not be “transitory”. The fall-out of war coupled with increasing inflationary pressures, China growth concerns and the rather strong February reporting season resulted in a very uncertain period, filled with questions, and one which made portfolio positioning challenging.
In the midst of all this, the February reporting season was quite fruitful for Australian companies as corporate earnings exceeded cautious market expectations. The most significant increases came from energy and financials due to sharp increases in the oil price and solid lending growth in an environment of low bad debts. With most companies optimistic on the outlook, the market regained in February/March all of what it had lost in January, and then some, to finish the quarter on a positive note, while both local and foreign investors chased Resource stocks and stocks that will benefit from higher interest rates.
At the sector level, as expected, the Energy sector (+28.6%), Materials (+15.4%), Utilities (+14.1%) and Financials (+4.5%) dominated the quarter. Information Technology (-13.7%), Healthcare (-10.1%) and Consumer Discretionary (-9.6%) were the biggest laggards as longer-duration growth assets were sold-off as a consequence of future interest rate hikes. Value orientated companies continued to outperform their growth counterparts, whilst as a result of heightened volatility, Mid-caps (-2.6%) and Small-caps (-4.2%) underperformed.
Global equity markets experienced the same selling pressures as the domestic market but in different months. The year began with smaller falls in January as elevated inflation and increasingly hawkish central banks all weighed on sentiment; and without respite these falls continued into February until the world was shocked as Russia’s invasion of Ukraine in late February caused a global frenzy in financial markets. A slight reprieve in March did little to halt the slide against a backdrop of 40-year highs in US inflation, an escalating crisis in Europe, China growth concerns and massive supply chain disruptions.
Quarterly performance varied greatly depending on region. Rate rise concerns weighed disproportionally on US markets given their higher multiples which saw the (S&P 500 NR) fall (-7.8%) whilst the tech heavy (NASDAQ Composite TR) fell even further (-11.8%) both in AUD terms. The broader global equity market (MSCI World NR AUD) lost (-8.2%); Eurozone equities (STOXX Europe 600 NR), as a direct result of its proximity/hostilities within the region and partly because of its dependence on Russian energy supply fell (-11.0%); and Emerging Markets (MSCI EM Index AUD) was firmly down as a direct result of geopolitical tensions losing (-10.0%). EM markets however were mixed. Whilst China, impacted by lockdowns and regulatory concerns; and EM Asia were down materially, India and Latin America, most notably commodity exporters such as Brazil, generated strong gains. Currency was also a detracting factor for unhedged returns as the Aussie dollar rose strongly in the period.
The Australian listed property sector (S&P/ASX 200 A-REIT), after a tough start to the year, did manage to claw back some performance however still ended the quarter in the red, down (-7.1%). This was in response to rising bond yields, from historical lows, and in particular rising ‘real’ yields which has historically resulted in underperformance relative to broader equities. Reporting season however was positive as earnings growth expectations for the financial year were ratcheted up by approximately 3%. Performance across niche sectors such healthcare, childcare, self-storage, and logistics continues to provide resilience and balance sheets across the sector remain strong.
Global listed property (unhedged) returned (-6.6%), slightly outperforming the domestic market. Persistent inflation (rising), the timing and scale of expected interest rate hikes and the turmoil between Russia/Ukraine weighed heavily on markets throughout the quarter. Global listed infrastructure (unhedged) provided some respite, recording a positive return of (+0.6%). Both asset classes continue to provide solid longer term returns - off the back of improving fundamentals, reasonable economic conditions, and the ability to afford some inflation protection. Although the sector also sold-off in February due to tensions in Europe, the sector should continue to be supported as global economies reopen and by infrastructure-led fiscal stimulus packages, decarbonisation, the ‘green’ transition and importantly, inflation-linked pricing models. Currency was also a detracting factor for unhedged returns as the Aussie dollar rose strongly in the period.
Global bond markets suffered their biggest losses since the 2008 financial crisis (March 2022 was the worst month in history for the Australian bond market) whilst major central banks globally began to action their tightening cycles as global bond yields surged higher throughout the quarter on the back of higher inflation and more hawkish central bank action and guidance. Yield curves inverted – signalling recession pressures – at odds with tightening policies. As inflation surged to multi-decade highs, certain central bankers felt they had little choice but to act with the US Federal Reserve (Fed) and the Bank of England (BoE) pulling the trigger raising their respective cash rates by 25 and 50 basis points. The European Central Bank maintained their marginal lending facility rate at zero percent for the near future however have discontinued asset purchases at the end of the quarter. The Fed and BoE will also begin reducing their holdings of treasury securities and corporate bonds at coming meetings.
Yields on 10-year treasuries, both domestically and globally continued their volatile ride throughout the quarter. The 10-year Australian Treasury yield almost doubled starting at 1.488% and finishing the quarter at 2.788%, whilst the 10-year US Treasury yield also increased significantly from 1.487% to 2.345%, touching multi-year highs throughout. The market appears to be pricing in 6-9 rate rises in most developed markets in 2022 with a further 2-4 in 2023 to rein in inflation. The dual goal of inflation control without hampering economic growth and potentially leading economies into recession is an extremely difficult task. Success or failure will have a significant effect on all assets.
The (Bloomberg AusBond Govn 0+Yr) returned (-6.2%) whilst global bonds (BBgBarc Global Aggregate TR Hedged) returned (-4.9%). Credit markets were quite volatile during the quarter and sold-off (albeit steadying in March) as the prospect of a more aggressive US Fed and the rising risk of a slowdown in economic growth triggered the widening of credit spreads in both Investment Grade and High Yield. Emerging Market bonds were however quite resilient in local currency with Brazil being the standout. Australian cash yields again remained untouched as the RBA left the official rate at 0.10% throughout the quarter.
Quarter in review
The quarter is best understood through a timeline of events, the first of which was triggered before the quarter started in the middle of December where the US central bank turned very hawkish very quickly, a combination of inflation data looking significantly more sticky than previously thought and the green light to start to remove stimulus as the covid-era restrictions appeared to have come to an end.
This culminated in the beginning of a “risk-off” environment in January which resulted in falls in the Aussie dollar, Australian equities & property, growth equities (e.g. technology), and bonds. Interestingly, bonds usually perform well in risk-off periods but not when inflation and the potential for rising cash rates is the cause of the risk-off environment. Strong economic growth and tight labour markets were a feature in January whilst inflation continued to rise in most countries, a function of some excess demand given the extraordinary amounts of both fiscal and monetary policy we saw over the last 2 years, but mostly a function of the continued disruption in supply caused by the Covid-related health policy responses. That inflation needs to be addressed given the risks of prolonged inflation becoming economically damaging and/or entrenched for longer than would be preferred.
Just as markets began to take inflation and supply issues in their stride, an ongoing Ukraine/Russia conflict which began way back in 2014, escalated when two eastern Ukrainian regions declared their independence and sought assistance (protection). Russia came to their aid, originally in a limited capacity, but this morphed into a full blown invasion with Russian troops entering Ukraine from all directions. This resulted in a broader risk-off environment, with both market and economic sentiment turning sour given the economic implications of war (likely recessionary for Europe), the impact of Russian sanctions on a globally integrated financial and economic world, the additional stress on supply chains given the significant amounts of production conducted and commodities extracted from both Ukraine and Russia, and the broader inflationary impacts putting even more pressure on central banks to act sooner and more aggressively than they would otherwise like with the backdrop of war.
This time it was global equities turn to fall sharply given the growth company sell-off continued to impact the US equity market with central bank rhetoric continuing to turn more hawkish, European equities fell given the regions proximity to the war in Ukraine, and broader risk off sentiment and ongoing Chinese government regulatory concerns saw Asian equities also fall. Bonds also fell again given inflation concerns which were further exacerbated by the war, particularly rising and high energy costs, whilst Australian equities attempted to reverse the strong falls seen in January with the resources sector benefiting from supply shortages and inflationary conditions.
March was largely a continuation of February with the war in Ukraine escalating whilst inflation concerns remained. But March did see the first US rate rise from the Fed, with the accompanying statement issued with more hawkish rhetoric than expected. Surprisingly, equity markets actually rose post the announcement, focusing on the clarity provided by the statement regarding the forward period rather than the rate rises that will follow. We also saw the Chinese government announce a 5.5% economic growth target for this year and a range of supportive measures to assist in meeting that target. Importantly, they also announced they were dropping their focus on technology and payment giants bringing an end to the almost 2-year regulatory crackdown on the power they had supposedly accumulated and were exerting. Also from a Chinese perspective, rising virus cases in Hong Kong and then through mainland China saw the government revert to locking down large cities, a continuation of their Covid-zero policy response, with disastrous effects on Chinese economic growth, household consumption, and business investment.
March saw the Australian equity market receive plenty of support from both local and foreign investors, with the resources sector surging, putting upward pressure on the Aussie dollar at the same time that the US dollar was also rising. Global equities finished flat, thanks to US equities which rallied post the Fed’s interest rate rise, whilst bonds suffered their worst monthly fall in some time as government bond yields rose aggressively as the market priced in an extraordinary amount of central bank rises over the course of this year.
Looking Forward
Overall, our outlook is mixed, in that:
For every positive there is a countering negative. That confirms that the recent period of higher volatility is likely to continue.
Two main things we will be watching closely, is how the inflationary environment evolves from here (i.e. stays high; falls slowly; falls fast) and how aggressive central banks will (or can) be in trying to fight inflation (i.e. not enough fight and high inflation becomes entrenched; too much fight and inflation falls too quickly risking recession).
As central banks try to engineer a soft landing, which is more difficult the higher inflation is, there will be ample risks to navigate around and opportunities to take advantage of. This makes for an interesting period ahead.
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.