April 26, 2024

Market & Economic Update - April 2024

AUTHOR

Financial Keys

POST SUMMARY

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%.

Australian Equities

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%.

The February 2024 company reporting season could be described as lacklustre although it did highlight stronger-than-expected results despite the higher inflationary and interest rate environment. The dominant themes that were showcased included consumer resilience, strong cost management, moderation in inflation and a positive economic outlook. Many companies have managed the higher inflation and interest rate environment reasonably well, beating market expectations, particularly in the IT, consumer discretionary and real estate sectors. The energy, materials, and healthcare sectors did not fare as well due to falling commodity prices and rising costs.

At the sector level, movement mirrored broader investor sentiment with Information Technology (24.4%), Real Estate (+15.3%) and Consumer Discretionary (+12.9%) leading the charge whilst Materials (-6.2%%), Communications (+1.1%) and Consumer Staples (+1.9%) were the laggards.

Across the market spectrum, solid returns were had by all however the resurgence of the smaller end of the market saw Mid-cap returning +6.6% and Small-cap +7.6%, outperforming their large cap index S&P/ASX 50 which delivered +4.9%.

International Equities

International equity markets flew out of the gates to overpower the domestic market as enthusiasm over A.I. continued to push developed markets to new all-time highs. Rightly or wrongly, the so called “Magnificent Seven” remain the most crowded trade and continue to heavily influence overall market returns. On the other side of the spectrum, China remained problematic as consumer and business confidence continues to be sapped by the turmoil that is the property sector.

The resilience of the U.S. consumer helped corporate earnings counter the effect of rising bond yields to push U.S. markets to new highs in January.  European markets also enjoyed a strong January off the back of IT and semi-conductor strength. Emerging markets started the year slowly, not helped by the relative strength in the USD, and being dragged down overall by the issues being experienced in China and general sentiment.

What was different in the quarter was the diverging fortunes of the 'Magnificent 7'. Whilst all have rallied hard over the past twelve months, the month was dominated by Nvidia and Meta Platforms both returning circa +25% and continuing their rapid ascent after posting strong quarterly results, while Apple and Alphabet both lagged the market. The Magnificent 7 which accounts for 29% of the market value of the S&P 500, was able to provide +37% of the quarter return however a breakout group of Amazon, Meta, Microsoft and Nvidia (18% of the market value of the S&P 500), accounted for +47% of the return leaving Apple, Alphabet and Tesla combining for an overall contribution of -10%.

In USD terms, the S&P 500 returned an impressive +10.4% for the quarter hitting a new high on March 29. This marked its best first-quarter gain since 2019. The tech heavy Nasdaq recorded +9.3% for the quarter once again led by strong results (led by Communications and IT sectors) and better than expected forward earnings forecasts.

In Australian dollar terms, all major indices provided strong returns; the broader global equity market (MSCI All Countries World NR AUD), gained +13.2%, Eurozone equities (STOXX Europe 600 NR), rose +10.1% off the back off signs of improving business activity; UK equities, FTSE 100 TR, seemed to have moved to price in sooner-rather-than-later rate cuts by the BoE, returned +7.8%; with Japan equities, Nikkei 225 Average TR, being the standout for the quarter returning an exceptional +18.4%. This was driven by foreign investment as optimism over Japan's positive economic cycle grew and corporate earnings exceeding expectations; and the MSCI AC Asia Ex Japan index retuned a solid +7.1% driven by Taiwan, Philippines and in most part by the continued fervour with India (robust economic growth, an infrastructure push).

Emerging Markets, although performing well, continued to underperform their developed peers as China remained problematic. The MSCI EM Index returned +7.1%; The MSCI China TR index returned a relatively mild +2.3%, struggling to build on recent gains even though there were signs of improving economic conditions. Investors however remained cautious.

Outside of China, EM Latin America was surprisingly disappointing after a strong end to the previous year and rate cuts in Brazil, Mexico, Colombia and Peru, returning an anaemic +0.4%, perhaps taking a breather; EM Europe returned a strong +10.6%, benefiting from broader EU positiveness and improving broader economic indicators.

After a brief pick up in the previous quarter, the Australian dollar lost ground on the USD, which seemed unusual as risk appetite rose, falling approximately -4.8% for the quarter, providing further gains for unhedged strategies.

Property & Infrastructure

After a dominant end to 2023, Australian listed property continued its upward trend in the first quarter of 2024. Although bond yields rose in February, AREITs continued their upward trajectory which perhaps indicates downside risk to valuations has been already priced in.

The sector as measured by the S&P/ASX 200 A-REIT TR Index returned +16.8% for the quarter to bring the six-month return to an incredible +36.1% – fair to say plenty of investors seeing value and reducing their underweight positions given the subsiding of economic fears. The concentration of the sector was on show with two stocks, Goodman Group and Scentre Group accounting for almost 45% of the overall index and with recent equity-like returns.

Global listed property lagged on a relative basis, with China property headwinds, US office vacancies, and Fed rate cuts being pushed out hampering returns in the quarter. The benchmark FTSE EPRA Nareit Global REITs TR index rose a moderate +3.0% for the quarter whilst the hedged quarterly return was hurt by a rising USD versus the AUD, falling -0.1%.

The infrastructure sector fell victim to rising real bond yields in February and continued uncertainty surrounding monetary policy easing. Profit taking and redeploying cash into broader global equities (risk-on) also hurt the sector.  This has exacerbated the relative underperformance in defensive sectors such as Utilities relative to more cyclical assets such as toll roads and other user-pay assets. Energy infrastructure companies were the winners due to higher oil prices, while the uncertainty over the timing of potential rate cuts in 2024, weighed on longer-duration communications and renewables sectors. The FTSE Global Core Infra 50/50 index rose +6.4% for the quarter, whilst the hedged equivalent posted a lower quarterly return of +2.7% due to an appreciating USD.  

Bonds and Cash

The March quarter could be best described as a rollercoaster with bond yields continuing their significant sensitivity to Fed cash rate expectations. At the end of 2023, markets had brought forward their expectations of Fed rate cuts to January/February with 6-7 cuts expected for the year. By the end of January, markets were projecting the first Fed cut in May-June with a total of 4-5 moves by end-2024. By the end of the quarter this had changed dramatically to 2-3 by the end of the year with no cuts until September. This would leave the Fed rate at 4.50%-4.75%.

The U.S. 10-year Treasury rose approximately 33 basis points during the quarter, starting at 3.89% and finishing at 4.22%. Major economies such as the UK and those in Europe also saw a scaling back of rate cut expectations whilst Japan was the ultimate exception with the Bank of Japan raising interest rates from -0.1% to 0-0.1%. The first time it has risen rates in 17 years, signalling an end to negative rates. The 10-Year Australian Treasury yield, after hitting a 12-year high last quarter, started the quarter at 3.94% and finished at 4.00%. A rise of only 6 basis point. The People's Bank of China slashed its reference for mortgages, the 5-year loan prime rate, by 25 basis points to 3.95% at the February fixing, above market forecasts of a reduction of 15 basis points  It was the first rate cut since June 2023 and the largest since that rate was introduced in 2019, as the board ramped up efforts to spur credit demand and reverse a property downturn.

Australian treasury bonds (Bloomberg AusBond Govn 0+Yr) rose +0.97% for the quarter, outperforming Global Treasury bonds (Bloomberg Global Treasury TR Hedged) (-0.34%) with valuations remaining fairly stagnant across the curve.

Regional credit market spreads contracted slightly during the quarter with Investment Grade spreads now approaching twenty-year highs, reflecting non-recessionary levels.  Global credit (Bloomberg Global Agg Corp TR) returned a very healthy +4.38% in AUD whilst the Australian corporate market (Bloomberg AusBond Credit 0+Y TR AUD), rose a more moderate +1.37%. Investment grade credit underperformed higher yielding credit in the quarter.

Most currencies depreciated against the US dollar during the quarter as the US economy remained resilient leading to reduced rate cut expectations.

Quarter In Review

The trend is your friend….

Another bumper quarter for equity markets, continuing from the strong December quarter, as momentum took hold of equity markets with investors hopping from one piece of “good” news to another to ensure the trend continued with the equivalent of another years’ worth of return provided in the period.

What drove the rally in the fourth quarter, i.e. end of rate hikes and increasing expectations for significant and early rate hikes in 2024, was walked back early in the quarter but equity markets didn’t seem to care at all, pivoting to embrace an economic “soft landing” as the new drug of choice as recession fears were suddenly no more. Not just that, but the magnitude of the moves upwards provided plenty of risk (opportunity cost) for those not fully invested or taking a more cautious stance.

Whilst equity movements were uneasily simple, strongly up, the read through to other asset classes and assets was not, providing a somewhat confounding picture for any multi-asset or macroeconomic lens. That is, stocks rose like central bank rate cuts are imminent (they are not), bond prices fell (yields higher) like rate hikes are more likely, gold prices rose like we’re entering a recession, and oil prices rose like the economy is perfectly fine.

All this whilst the Russia/Ukraine war continues with no end in sight, the Middle East tensions are rising, and an upcoming US election which might prove to be the most important for some time.

What’s driving all this? Simple anecdotes are always easy, but the truth is generally found after the fact, whilst the search for the truth in the short term (i.e. generally guessing) creates both opportunities and risk.

Economic data remained robust in the March quarter, validating the shift in consensus to a likely soft-landing scenario whereby economic growth slows enough to bring inflation down into target but not enough to result in a recession. Employment trends remained robust, though the significant shift in new employment from full-time to part-time is worth watching. Retail sales weakened in the quarter, but continue to come off a relatively high base, showing the household still has some spending capacity. Bad debts are rising but off a very low base and in very select parts of both the economy (sector) and assets (cars, credit cards). All this whilst house prices continue to rise given the significant shortage in supply, supported by hopes of rate relief just around the corner.

This last bit of economic resiliency continues to make central bank rate cut calls even harder, with plenty of mixed messaging. Central bankers would like to take their foot off the tightening pedal, even if only slightly, but can’t do so with governments continuing to spend big. If they provide rate relief too early, they run the risk of inflation re-accelerating, and recent inflation stickiness shows the risk is real. That likely means that any rate relief is now likely to be a second half of 2024 story and into 2025. Interestingly, emerging market economies now look likely to offer rate relief before more developed economies, which should play out in asset prices.

Geopolitics and politics rarely impact markets outside of the very short term, but the more flashpoints received the harder it is for markets to ignore, and it’s fair to say tensions escalated further in the quarter and look like they will escalate further in the next quarter.

Outlook

We continue to be quite conscious of the extremely healthy returns being provided on risk assets, particularly equities. Participation in markets remains key. But we also remain very conscious of the increasing disconnect between price movements and fundamentals, and wearily aware that slowing economic growth without rate relief could put company earnings at risk.

Whilst we remain long term investors, we continue to take in a significant amount of information in the short-term to see if we can narrow the likely expected paths over the next 12-24 months. For now, we remain cautious, and well diversified, but not fearful, as the current momentum in markets can continue for longer than rationality should allow.

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