January produced a stellar return of (+6.23%) however as the quarter progressed, it was clear rising interest rates had started to take their toll on sentiment. As financial conditions continued to tighten sharply, the equity market began to cool. Although the quarter ended in positive territory, (+3.46%), the final two months fell a combined (-2.60%).
The February reporting season produced a mixed bag. Higher interest rates and a slowing economy were the key thematics heading into a highly anticipated season. At the end of the day, some companies reported excellent results and record profits, indicating the resilience of their business models, whereas others cut dividends and provided less than rosy outlooks. Cost controls, debt repayments and maintaining margins will be critical for the year ahead. Forward earnings guidance was minimal due to high levels of uncertainty. Pricing power and the ability of companies to pass on additional costs to the end user will go a long way in determining how they perform in 2023 and separate the good from the mediocre.
The Australian market underperformed their global counterparts in AUD terms for the quarter (+9.1% for global equities), as the overweight to big miners and banks worked against the local market this time around. The shallow domestic market might be in for a very volatile year as a result of its overdependence on resources/materials. Recent economic data is suggesting a slowdown and whilst the reopening of China is a positive, it remains to be seen if that alone is enough to stave off recession.
At the sector level, all but two sectors, Financials (-2.66%) and Energy (-1.04%) provided a positive return. Consumer Discretionary (+11.98%) leading the way. Spending has yet to see significant change however it will be hard to maintain these levels as the full impact of this rate-tightening cycle have yet to be seen/realised. Communication Services (+9.37%) and Information Technology (+8.10%) also performed strongly whilst Materials (+7.72%) might start to feel the pinch in the coming quarters as the macro backdrop becomes more bearish. Real Estate continues to be under pressure not helped by the SVB (Silicon Valley Bank) collapse and the risk of contagion to other small end banks and commercial property valuations.
Across the market spectrum, the rally in January rose all segments however cooling markets since have brought about some divergence. All remained in the black for the quarter with the larger caps, S&P/ASX 20 (+3.4%) and S&P/ASX 100 (+3.5%), outperforming the smaller S&P/ASX MidCap 50 (+0.01%) and S&P/ASX Small (+1.88%).
International equities also began the year very strongly with gains across all regions as the reopening of China and an improving inflation outlook set the tone for markets in January. Despite an extremely noisy start to the year and high levels of market turbulence as a result of some bank collapses, all major countries/regions ended the quarter in the black.
The S&P 500 rose a healthy (+7.36%) for the quarter, whilst the tech heavy Nasdaq shot up (+17.05%). Both indices benefitting from the drop in real bond yields as investors sought longer duration growth assets such as Information Technology (+21.65%) and Communication Services (+21.27%). In AUD terms, both indices outperformed for the quarter, (+8.70%) and (+18.51%) respectively, which reflected the depreciation of the Australian dollar (-1.1%). The slight depreciation of the Australian dollar provided a small level of outperformance for unhedged strategies in the quarter.
In Australian dollar terms, the broader global equity market (MSCI World NR AUD), provided a solid gain of (9.8%) for the quarter; Eurozone equities (STOXX Europe 600 NR), continued their stellar short-term run, surging (+11.73%) during the quarter helped by a significant fall in inflation. Gas prices collapsed during the quarter as the March CPI dropped to 6.9%, well down on the 10.6% peak in October 2022; UK equities, also continued their upward trajectory, with the FTSE 100 TR adding a further (+7.78%). This was driven predominantly by optimism amid hopes that central banks might be in a position to ‘pivot’ to cutting interest rates in late 2023.
Emerging Markets (MSCI EM Index) posted another solid return for the quarter helped by further overall relative weakness in the USD and by China reopening. The re-opening of the Chinese economy and broadly, a more market-friendly policy backdrop, has fuelled a large rally in Chinese equities, whilst at the same time spilling over to Taiwan and South Korea. The index finished the quarter up (+5.26%); The MSCI China TR rose (+6.02%) for the quarter; the broader ASEAN followed the broader EM movement with the MSCI AC ASEAN NR rising (+4.11%) led by Taiwan (+14.29%) and Korea (+10.10%), the beneficiaries of optimism about China. The MSCI EM Latin America NR ended the quarter on a positive note, with a return of (+5.23%), but underperformed broader EM indices.
The Australian listed property sector (S&P/ASX 200 A-REIT), after a stirring start to the year (up 8.12% in January), once again fell victim to rising real bond yields and poor sentiment. The benchmark index ended the quarter up a fraction (+0.52%), after falling with the broader market in February and followed by a sharp sell-off in March as negative sentiment gripped the sector on the demise of some foreign banks.
Global listed property started the year strongly however rising rates and fears of banking contagion reversed the earlier gains, as the latter raised serious concerns that tighter financial conditions could make commercial real estate refinancing extremely difficult. The benchmark index still managed a positive unhedged quarter return of (+2.94%), however this was significantly lower than broader global equities. All property sectors remain under pressure as recession and fears of a credit crunch keep growing.
The infrastructure sector continues to benefit from its defensive characteristics, but also the positivity from being exposed to secular themes, including broader reopening, years of underinvestment, and the energy transition. The energy infrastructure and electric utility sub-sectors lead the way, with airports and user-pay assets such as toll roads also performing strongly, especially in Europe, as pent-up demand from travel drove prices.
The FTSE Global Core Infra 50/50 index (unhedged) bounced back in March to end the quarter up (+2.0%). The hedged equivalent fell (-0.17%) as the AUD suffered further relative losses.
Global bond markets started the year very much on a positive note (bond yields continued to fall) following a volatile December quarter as sentiment rose off the back of the reversal of China’s zero-covid stance and increased optimism on the global growth outlook. Central banks kept raising rates, albeit in smaller increments, with inflation starting to abate as energy prices fell, supply side issues improved, and higher interest rates began to impact consumption.
After continuing to stabilise in January with further rises in bond prices (falling bond yields), February saw all gains given back as higher than expected inflation readings and ongoing labour market strength resulted in sharp rises in bond yields. Yields rose into March, however, the collapse of SVB and Signature Bank, followed by Credit Suisse, saw extreme volatility with yields moving at times 40- 50 basis points within days. The MOVE Index, which tracks market volatility in bonds, reached levels not seen since the GFC (Global Financial Crisis).
During the quarter, the Federal Reserve raised its Funds Rate from 4.25%-4.50% to 4.75%-5.0%, pushing borrowing costs to new highs since 2007, as inflation remains elevated. The Bank of England raised rates a total of 0.75% to end the quarter at 4.25% whilst the ECB (European Central Bank) followed suit with two hikes of 50 basis points elevating their current bank rate to 3.50%, levels not seen since 2008. On the other side of the coin, the People's Bank of China (PBoC) kept its key lending rates steady for the seventh straight month, holding firm on not providing any major stimulus just yet. Meanwhile, the RBA also took its official cash rate to 3.6%, raising in both its meetings by 25 basis points. Whilst the level of increases has slowed, all remain cautious and ready to re-accelerate the pace of hikes should inflation persist.
The 10-year Australian Treasury yield started the quarter at 4.05%, trading to as low as 3.19% before ending the quarter at 3.24%. An overall fall of 0.81%.
The 10-year US Treasury yield started the quarter at 3.88%, and whilst briefly hitting above 4% in early March, dropped to as low as 3.29% in mid-March before ending the quarter at 3.49%.
Australian bonds (Bloomberg AusBond Composite 0+Yr) provided a healthy return of (+4.60%) whilst Global bonds (Bloomberg Global Aggregate TR Hedged) returned a solid (+2.38%). Both indices rising strongly as yields came roaring back in.
Most currencies continued to appreciate against the US dollar during the quarter. The AUD peaked to close to 0.71 in January before easing down to 0.66 by quarter end, due to a combination of risk-off trading (negative AUD) and interest rate differentials (favouring foreign currencies).
The March quarter was largely a positive one for investment markets, but it felt like we went through ten rounds in the ring to get there.
It was a tale of three completely different months with wild swings in investor sentiment and expectations the driving force behind investment markets.
January started off with a bang, in stark contrast to December returns, with investors feeding on any positive news they could get their hands on. This included but wasn’t limited to: European energy crisis averted (a milder winter and the US provided support via their strategic petroleum reserves); US company quarterly reporting season came through better than expected (though weaker than the same time last year); China reopening, which began in November, continued supporting the outlook for global supply chains and Chinese demand; and the changing interest rate dynamic (flipped to dovish) as the US central bank shifted to smaller rate hike increments (i.e. 0.75% to 0.50% in December 2022 and 0.5% to 0.25% in February). That resulted in equities and property powering ahead (i.e. monthly gains more akin to annual returns) and bonds producing one of their best months in over a year. It all seemed too much too soon, but no one was complaining after a year like 2022.
That positive sentiment spilled into the early part of February but was short-lived as concerns arose regarding the pace and balance of China reopening in the absence of reasonable to significant government / central bank stimulus; and Western central bank rhetoric turned more hawkish as they moved to put a lid on animal spirits by reminding investors that they still have a long way to go bring inflation under control. That hawkish tone sent investor sentiment packing as expectations of a “soft landing” or a central bank pause very quickly disappeared and not helped by opportunistic profit taking following an unusually strong January.
That negative sentiment carried into March until we saw US banks come under pressure as a crisis of confidence hit Silicon Valley Bank and a few others, either linked to the technology / crypto sector or smaller regional banks. Interestingly, this wasn’t GFC mark II given bad debts remain incredibly low and banks generally well capitalised. It was a function of a sector under pressure (i.e. technology sector) as the irrational exuberance of the Covid period washed out, a concentrated relatively affluent customer base, and terrible treasury management by the banks themselves. US regulators moved swiftly to protect deposit holders and provide a liquidity backstop to the banking system. However, the negative investor and concerned deposit holder sentiment shifted to Europe with Credit Suisse identified as the weakest link, which culminated in a swift and quite unusual bailout by Swiss authorities, sending reverberations through some parts of the bond market.
Interestingly, investor sentiment and expectations shifted drastically in a positive direction on the view that either central banks won’t raise rates any further to protect the banking / financial system (a misguided view in our opinion) or won’t have to raise rates any further as the banking system tightens financial conditions themselves thus doing the remaining heavy lifting for central banks (definitely possible). Markets were always going to rally on a whiff of an impending pause in central bank rate hikes, but investors took it one step further by bringing forward their expectations of rate cuts. That change in expectations, and oddly positive sentiment, saw markets rally exceptionally strongly in the back end of the month with global equities and bonds attracting all the attention; Australian equities didn’t get the memo, and property fell sharply on concerns regarding the economic outlook and tighter financial conditions in the period ahead.
The Australian dollar fell from US71c to US66c in the quarter assisting unhedged global equity, property, and infrastructure allocations, as currency investors moved to a risk-off stance.
Given the above, the outlook remains incredibly mixed.
China reopening is a big positive but will likely need stimulus to sustain it, with question marks surrounding the health of China’s main trading partners (i.e. the US and Europe). A stressed banking system is never good, but it might tighten financial conditions enough so that central banks don’t need to go much higher from here on the rates front. Inflation appears to have peaked in most jurisdictions but the path lower will be key - inflation falling too sharply risks an uncomfortable recession whilst inflation falling too slowly will force central banks to continue raising rates or to keep conditions tight for some time. Bad debts and corporate bankruptcies are rising off a very low base but remain low for now. Labour markets remain very tight, continuing upward pressure on wages (additional consumer firepower to spend) and costs for businesses (good for those with pricing power, bad for those without). Supply chains have improved considerably alleviating some inflationary pressures, but trends regarding decarbonisation and de-globalisation are inflationary forces that central banks have only blunt tools to deal with.
All in all, plenty for markets to contend with this year. A mixed outlook isn’t necessarily bad for markets, but it does mean investment selection and diversification will be critical. We see both risks and opportunities – risks mitigated by owning high quality assets; opportunities taken advantage of through patience and remaining calm.
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.