January 27, 2023

Market & Economic Update – January 2023

AUTHOR

Financial Keys

POST SUMMARY

The Australian equity market (S&P/ASX 200 TR) continued its recovery after a poor first-half of 2022 and although pulling back in the month of December, returned a strong (+9.4%) for the quarter to finish off 2022 just slightly in the red at (-1.1%). The month of November provided the yearly highlight (hitting 7-month highs) as shares rallied off the back of falling treasury yields. 

Australian equities

The Australian equity market (S&P/ASX 200 TR) continued its recovery after a poor first-half of 2022 and although pulling back in the month of December, returned a strong (+9.4%) for the quarter to finish off 2022 just slightly in the red at (-1.1%). The month of November provided the yearly highlight (hitting 7-month highs) as shares rallied off the back of falling treasury yields. Sentiment improved during the quarter as the level and frequency of future interest rate rises became somewhat dovish (view to the downside) as falling monthly CPI (Consumer Price Index as an indicator of inflation) numbers were printed.

The Australian market outperformed its global counterparts in AUD terms for the quarter (+4.1%), benefitting in part from its skew towards the big miners and the banks and its relatively smaller exposure to technology companies. More notably, Materials and Energy sectors rallied strongly in response to rising iron ore, oil and gas prices and easing China Covid policies. The less aggressive monetary policy of the RBA on a relative basis, also sheltered the domestic market and contributed to the outperformance. Laggards included Real Estate and Consumer Discretionary sectors.    

Across the market spectrum, the rally in November and positive December quarter returns helped minimise the yearly damage.

International equities

The December quarter continued to be dominated by interest rate and inflation data and to what extent central banks globally, would go to reign in decade high inflation numbers at the risk of global recession.

After a good start to the quarter, off the back of the November rally, markets were given a dose of reality in December, giving up significant ground following a hawkish (view to the upside) December US central bank meeting and a surprise change to Japanese monetary policy. Quarterly performance across most regions were consistent in direction and depth as hawkish developed central banks continued to implement aggressive tightening policies (interest rate rises), including the Bank of England, the ECB (European Central Bank), and the central banks of Denmark, Switzerland, Norway and Canada.

The S&P 500 (measure of the US stock market) rose a healthy (+7.4%) for the quarter, whilst the tech heavy Nasdaq (index used to measure the technology sector of the US stock market) lost (-0.8%). In AUD terms, both indices underperformed given the positive quarterly movement of the Australian dollar (+5.5%). In Australian dollar terms, the broader global equity market (MSCI World NR AUD), provided a solid gain of (4.1%) for the quarter, assisted by Eurozone equities (STOXX Europe 600 NR) which surged (+13.5%) off the back of economically sensitive sectors such as Energy and Financials. Emerging Markets (MSCI EM Index), posted strong returns over the quarter helped by a relative weaker USD and optimism of a shallow slowdown given China reopening.

Property & Infrastructure

The Australian listed property sector (S&P/ASX 200 A-REIT) started the quarter off with a bang. Strong performance in October and November underpinned by stabilising and then falling real yields, pushed the sector up circa 16.0%. However, as bond yields started to rise in December, the sell-off began with the quarter still managing to provide a healthy return of (+11.5%). Rising ‘real’ bond yields and the higher probability of recession continue to supress prices of the listed property sector, which remain circa 20% below the net value of the assets.

Global listed property (unhedged) eked out a moderate return of (+1.3%) for the quarter. Rising real yields and inflation concerns will continue to undermine valuations in the listed sector which remain at discounts to net assets (circa 20-25%).

Global listed infrastructure (unhedged) (FTSE Global Core Infra 50/50 index unhedged) returned (+3.6%) for the quarter. Sector returns continued to be mixed with utilities sensitive to real yields and user-pay assets (i.e. toll roads, airports, rail) economically sensitive, whilst European concerns subsided on a milder winter than expected and Asian and emerging market assets benefited from China reopening sentiment. 

Bonds and Cash

Global bond markets steadied somewhat in October and November however the month of December reversed some of that as yields rose strongly (prices lower) following further rate rises and US Fed chair Jerome Powell reaffirming the bank’s ongoing goal of crushing inflation. There was also the surprise Bank of Japan change to its yield curve control policy which saw the BOJ widen the range in which they will manage (control) government bond yields which sparked a sell-off.

The world’s most aggressive and synchronised monetary policy tightening (interest rate rises) in 40 years entered a new phase as central banks prepared to slow the pace of interest-rate increases. During the quarter, the Federal Reserve hiked rates by 125bps to 4.25%-4.50%, pushing borrowing costs to the highest level since 2007, the RBA lifted by three lots of 25bps bringing the official rate to 3.10%, whilst the European Central Bank lifted rates by 125bps bringing the rate 2.75%, a level not seen since 2008.

Yields on 10-year treasuries, both domestically and globally continued their volatile ride throughout the quarter. The 10-year US Treasury yield started the quarter at 3.74%, peaked in late October at 4.28%, retraced down to 3.42% by mid-December off the back of favourable inflation readings, before settling at 3.88% at year-end.

Australian bonds (Bloomberg AusBond Composite 0+Yr) were slightly positive for the quarter at (+0.38%). Global bonds (BBgBarc Global Aggregate TR Hedged) returned slightly better (+0.6%) for the quarter. Emerging market debt was the best performing sector of the quarter, returning (+7.4%) in local currency.

Most currencies appreciated against the US dollar during the quarter led by the Yen after that surprising move by the Bank of Japan, with the AUD/USD moving from 64c to circa 68c in the period.

Quarter In Review

The December quarter saw a strong period for markets locally and globally, providing a positive end to a very tough calendar year where almost nothing worked outside of cash and private assets (which have yet to be revalued).

The positive quarter in markets was driven by improvements (or no worsening) of risks surrounding central bank policy tightening, inflation, and China lockdowns, with investors comfortable enough to dip their toes back in the water with plenty of assets showing valuation appeal.

Whilst central banks continued tightening policy in the quarter by raising rates and shrinking their balance sheets, many did slow the pace of tightening in addition to comments that seemed to indicate that they had done most of the heavy lifting.

That was somewhat confirmed by inflation data in the US abating whilst leading economic indicators continued to weaken, resulting in rising recessionary concerns for 2023. Housing markets locally and globally capitulated, with data worsening, whilst consumption and labour markets remained way too strong for any sort of central bank pivot. Investors can only hope.

President Xi of China was re-appointed, now as their “leader for life”, delivering a speech that the West interpreted as being hostile to non-China interests. Not long after that event, China swiftly moved meaningfully to a covid reopening plan with restrictions easing over the quarter, finally giving investors comfort that this reopening would be sustained. This put a rocket under Chinese assets, and Asian and emerging market assets more broadly, which had been under significant pressure for the better part of two years as China lockdowns persisted.

There was no major new or positive news out of Russia / Ukraine with fighting continuing. Further agreements were made to let more agricultural products out through the Black Sea thus assisting global supply constraints whilst the European proposed price caps on Russian oil were adopted by the G7 countries.

Lastly, new leaders came to power in the UK and Brazil, with the UK debacle one for the history books whilst Brazil moved back to the Left. In the US, the Republicans won the balance of power in the House, largely as expected, giving President Biden a much harder path from which to lead.

Outlook

Given the above, we expect economic data to continue to worsen in Q1 as central banks remain committed to bringing inflation under control. Corporate earnings season will be watched as closely as ever for any signs that earnings may need to be revised lower yet again. We think inflationary pressures will continue to abate but not at a fast enough pace to stop central banks from tightening policy again. We, like others, will be watching consumption and labour market data very closely for any signs of weakness given both remain unusually strong. This all makes for a likely continuation in heightened market volatility during a period where we should start getting answers, or a clearer picture, on what lies ahead.

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