December Quarter Review

Economic Overview

Q4 was a very positive end to the year, and despite the gloomy outlook many had for 2023 it was a fruitful one for investors who maintained a bias towards growth in their portfolios. Inflation continued to moderate in the US, while economic growth held up, continuing to defy any recession forecasts. Despite energy inflation looming as a worry during Q3, due to production cuts coming from Saudi Arabia and Russia, crude oil prices fell in Q4. Notably, and to the surprise of many, the US hit a record for oil production in November, and is estimated to have added an additional 1.2 million barrels per day of production in 2023. Sharemarkets were strong across the board in Q4. Australian shares saw a high single digit return for the quarter, rounding out a low double-digit gain for the year, while unhedged global markets punched out a mid single figure return for the quarter, to finish with a return in excess of 20% for 2023. Bonds also had a strong quarter, with yields falling and prices up, this rounded out the first respectable calendar year return for the asset class in some time.

In the US, GDP grew at an extremely hot annualised rate of 4.9% in Q3 2023, this was significantly up from the Q2 figure of 2.1%, and the strongest figure since Q4 2021. Real-time GDPNow tracking showed the US economy wasn’t as strong in Q4, but forecast to come in near 2.3%. The sharp increase in Q3 GDP was driven by consumer spending, contributing 2.11%, while private investment was also strong, adding 1.74% to the GDP number. Government spending added 0.99% to GDP, with increases in expenditure across all levels of government.

Annual inflation slowed from 3.7% in September to 3.2% in October and 3.1% in November. The Federal Open Market Committee also left rates unchanged for the third consecutive time during its December meeting, keeping the federal funds rate at a target of 5.25% to 5.50%, but it was the dovish tone which helped light up equity markets in Q4. Minutes from the meeting showed policymakers expect rates to end 2024 at 4.5%-4.75%. Fed chair Jerome Powell indicated that the central bank was aware of the risk of keeping rates too high for too long. This dovish pivot was in contrast to the message conveyed from Q3 where the FOMC signalled its intent to keep rates elevated for longer than anticipated.

US oil production hit a record high of 13.2 million barrels per day in the quarter, while US natural gas production was also near its all time high throughout the quarter. The US now exports more oil than any single country in OPEC. It’s an interesting outcome because the Republican side of politics in the US has implied President Biden was planning to kill off the US oil industry due to a suspension of oil and gas leasing on public land and offshore, which led to a belief US oil production was dying off. On the flipside, the Democrat side of politics, and President Biden’s Whitehouse, haven’t given much attention to the record oil production numbers, presumably because it contradicts their messaging on green energy and the environment.

Finally, on the housing front, the National Association of Realtors Housing Affordability Index, a noted measure of home buying affordability, is near its lowest level since 1985. The increase in interest rates has seen the average mortgage payment now over 50% higher than the average monthly rental payment. This has pushed buyers out of the market and into rentals, pushing rent prices up, with rents for single-family homes increasing more than apartment rents in 2023. In another grim stat, the number of homeless individuals in the U.S. has reached historic levels.

Source RBA 2024

In the Eurozone, interest rates continued to weigh on the economy. Eurozone GDP fell by -0.1% quarter-on-quarter in Q3. This followed two consecutive quarters of 0.1% growth and one of -0.1% contraction, leaving the Eurozone economy near flatlining across the past 12 months of available data. The positives were household consumption increasing by 0.3%, while public spending also increased by 0.3%. Euro area annual inflation fell to 2.4% in November from 2.9% in October. The ECB held rates across Q4 at 4.5%. Among the Eurozone’s largest economies, Germany -0.1%, France -0.1%, and the Netherlands -0.2%, all saw falls in GDP, while both Spain and Italy saw growth at 0.3% and 0.1%, respectively. The flash eurozone purchasing managers’ index (PMI) also fell to 47.0 in December, signalling further contraction in the manufacturing and service sectors.

In the UK, inflation moderated more than expected with CPI falling to 3.9% in November. This contributed to hopes that the Bank of England may have finished with rate increases. The UK economy also contracted -0.1% in Q3 2023, down from prior estimates of a flat reading. Figures for Q2 were also revised lower to show no GDP growth instead of an initial estimate of a 0.2% expansion, highlighting the UK is nearing recession. The services sector fell -0.2%, business investment declined -3.2%, while government consumption was revised higher at 0.8%. Chancellor of the Exchequer Jeremy Hunt announced more policy measures to try and jumpstart growth. Including an extension of the 100% capital expenditure allowance, this allows companies to deduct expenditure on plants and machinery from taxable income.

In Japan, data showed the economy contracted -0.7% in Q3 of 2023, after 1.2% and 0.9% growth figures in the prior two quarters. The contraction came about through elevated cost pressures and mounting global headwinds, however the Bank of Japan tankan survey released in December highlighted ongoing improvement in business sentiment across manufacturing and non-manufacturing sectors. Capital expenditure plans also signalled strong demand in machinery and IT services. The BOJ made gradual steps to normalise its extraordinary monetary easing policy at the end of October and hinted that they are likely to take further action early in 2024.

In China, GDP growth for Q3 came in at 1.3%, beating expectations of 1% and accelerating significantly on the revised 0.5% growth figure for Q2. Q3 was the fifth consecutive period of quarterly growth, coming on the back of further monetary stimulus measures, including rate cuts and liquidity injections by China’s central bank. The property sector continues to be the biggest issue for the Chinese economy, as China’s biggest property developers stare down default. Age is also becoming a factor in China, with over 280 million people now aged 60 or older, but businesses that once targeted infants are now shifting their focus toward Chinese seniors, so there’s always opportunity in an economy!

In Emerging Markets, Brazilian inflation continued to moderate into the mid 5% range, which saw the central bank drop rates twice across the quarter, however figures showed the economy slowed to 0.1% growth in Q3. In South Africa there were fewer incidences of electricity load shedding across the quarter, but data showed GDP fell by -0.2% in Q3. In India the central bank continued to hold the policy rate at 6.5% as inflation moderated and GDP growth remained consistent, while the ruling Bharatiya Janata Party also saw strong results in key state elections. In Turkey inflation remained very high, over 60%, with the central bank increasing rates to 42.5% in December.

Back in Australia, data released in December showed GDP increasing by 0.2% for Q3 2023, with the economy growing by 2.1% over the financial year. GDP per capita, noted as a proxy for living standards, fell over the quarter again, down -0.5%. Inflation data was mixed but encouraging, with monthly CPI coming in at 5.6% for the year ending September 2023, up from 5.2% in August, but the October figure fell to 4.9% and November dropped to 4.3%. This was the lowest monthly figure since January 2022, with food, transportation (fuel prices), health, along with recreation all easing, with prices falling for household equipment and services. Clothing and footwear prices continued to fall.

There was one rate increase during Q4, as the RBA increased the cash rate from 4.1% to 4.35%, with the RBA noting “inflation in Australia has passed its peak but is still too high and is proving more persistent than expected”. The RBA target is 2-3%. The household savings rate fell to 1.1% in Q3 and is now at the lowest level since 2007. On its current trajectory the savings rate will soon be negative, something that hasn’t been seen since the mid 2000’s.

Housing prices continued to increase, with no capital/regional divergence during Q4. Both the combined capitals and combined regionals were each up 1.5%. Sydney was up 0.8% for the quarter and 11.1% annually, according to CoreLogic. Every capital registered a gain in Q4 except Melbourne, down -0.8%. The strongest markets for the quarter, were Perth at 5.1%, and Adelaide and Brisbane both at 3.7%. Hobart and Darwin were the only capitals to see a decline on an annual basis, down -0.8% and -0.1% respectively. Rents continued to push higher, with an increase of 9.8% across the combined capitals for 2023. Not surprising, as the government runs a record immigration program while monthly dwelling approvals sit 20% below the decade average.

Market Overview

Asset Class Returns

The following outlines the returns across the various asset classes to 31 December 2023.

Global sharemarkets delivered a strong returns in Q4 following a modest US inflation figure in November, the US Federal Reserve signalling interest rate cuts might be in the pipeline for 2024, and energy prices falling across the quarter. The Australian market was up 8.67% for the quarter, while Australian listed property really powered up with a double-digit return, though it should be noted it still sits well below its December 2021 peak. Bond prices increased in Q4 as yields fell, with the market turning its attention toward potential rate cuts in 2024. The 10-Year US Treasury yield fell for most of Q3, finishing at 3.86%. US 2-year yields also eased during Q3, with most of the movement in November and December, down from 5.05%, to finish at 4.25%. In the UK, the 10-year yield fell from 4.44% to 3.53%, dipping significantly in December. The Australian 10-year yield started the quarter at 4.5% and moved upward during October, before falling throughout November and December to end at 3.9%.

In the US, the S&P 500 was up 11.69% for the quarter, finishing up 26.29% for the year. It was once again “The Magnificent Seven” of Apple, Microsoft, Alphabet, Amazon, Tesla, Nvidia and Meta doing the heavy lifting, this seven contributed 15.5% of the S&P 500’s gain in 2023, while the other 493 stocks added 10.8%. it was excitement over the emerging field of artificial intelligence that helped propel some of the mega-caps, but profitability was also a factor. The Magnificent Seven are expected to post a 39.5% increase in aggregate earnings for 2023. The Russell 2000 small-cap index was up 14.03% in Q4, finishing up 16.93% for the year. Top performing sectors were those most sensitive to interest rates, including real estate, technology, and consumer discretionary. Financials and industrials also posted strong gains. The energy sector was slightly negative with crude oil prices weaker, while utilities were the worst performer.

In the Eurozone, there was strong performance in Q4 with the MSCI EMU index up 7.8%.  In France the CAC 40 was up 5.72%, while the German DAX was up 8.87%. The strong performance came from expectations that further interest rate rises were unlikely. Most sectors rose amid optimism over future rate cuts. The real estate sector advanced strongly due to the potential for cheaper debt. Technology companies also performed well, while economically sensitive sectors such as industrials and materials delivered strong gains. By contrast, healthcare and energy were the two main laggards, with negative returns.

In the UK, equities rose over the quarter, but large caps were more muted than in other markets as larger companies struggled with the pound’s outperformance against a weaker US dollar. The large companies that did best were in economically sensitive areas of the market such as the industrial and financial sectors. The FTSE 100 only managed a 1.64% gain for Q4, while the mid cap FTSE 250 was up 7.71% and small caps were up 5.38%. Like elsewhere, the performance was mostly underpinned by increasing hopes interest rates may have peaked, while there was also a higher interest in smaller UK companies from overseas investors.

In Japan, large companies saw the best performance across Q4, with a 5.04% gain for the Nikkei 225 index. In contrast, the broader TOPIX Total Return index only notched a 2.0% gain for Q4. Most of the gains were seen in November as October and December were flat to weak. In October, worries that US interest rates may remain higher for longer weighed on the market, while geopolitical risks, such as conflict in the Middle East, caused some concern. However, investor sentiment improved, due to weaker-than-expected macroeconomic figures in the US and the expectation of rate cuts. While the US market continued to rise in December, the Japanese equity market lagged as investors became concerned about yen appreciation. From a corporate fundamentals standpoint, things remained strong, with the first half of the fiscal year concluding with quite strong earnings results.

Asia (ex-Japan) and Emerging markets were strong in Q4 2023, albeit lagging developed market equities. The “soft landing” narrative for the US economy and potential for rate cuts in 2024 were supportive. However, China’s outsized influence continued to be a drag on broad emerging market performance. Poland was the top performer as markets welcomed Donald Tusk’s election as prime minister at the head of a pro-EU liberal coalition government, ending the eight-year rule of the Law & Justice party. Peru, Egypt and Mexico also posted strong returns. Brazil’s outperformance was helped by moderating inflation and rates cuts, while Taiwan and Korea saw strong performance due to their technology sectors. Negative returns were seen in Kuwait, UAE, China, and Turkey, which was one of the worst performers as raging inflation took its toll.

The Australian market (All Ords Accumulation) was up 8.67% in Q4 rounding out a 12.98% return for 2023. October was mostly flat before the tailwind of moderating inflation and the US rate cut narrative took ASX on a two-month rally. This also coincided with gains in the iron ore price throughout November and December due to Chinese stimulus, which saw the big miners get a lift.  The big winner in Q4 was listed real estate, up 16.5% as the sector salivated at the prospect of rate cuts. Health care saw strong gains as CSL rallied after months in the doldrums. Materials were up 13.17% off the back of the iron ore price rise. Financials slightly lagged the index, with consumer staples flat. The only two sectors in the red for Q4 were utilities and energy, which saw a -8.97% loss as the oil price spent the quarter falling. ASX small ordinaries were up 8.52% for the quarter, but only up 7.82% for the year.

This material is provided for information only. No account has been taken of the objectives, financial situation or needs of any particular person or entity. Accordingly, to the extent that this material may constitute general financial product advice, investors should, before acting on the advice, consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation and needs. This is not an offer or recommendation to buy or sell securities or other financial products, nor a solicitation for deposits or other business, whether directly or indirectly.

Federal Budget

The 23/24 Federal Budget has been released and thanks to strong commodity prices it looks better than would have been expected a year ago. Some of the key areas addressed in the budget were cost-of-living, social security payments, investment in Government services and attempting to alleviate inflationary pressures, though time will judge its impact on inflation.

There is a small and brief return to surplus in this budget, though this will be confirmed in a few months time when the actual numbers are in. However, the budget is then forecast to go back into deficit until 2026/27 at least. Net debt is expected to be over $700 billion by that financial year.

Always with forecasts, be they investing or economic, they need to be taken with a grain of salt when they look beyond a quarter or half year. In the final budget before the election last year, the forecast for inflation was a peak of 4.25%, before falling to 3% in June this year. Inflation is currently more than double that figure, but the budget forecasts a fall to 3.25% next year.

On that topic it pays to remember Scott Morrison’s “we brought the budget back to surplus next year”. It was impossible to have a surplus in a future that hadn’t occurred. What occurred in that next year was Covid. A dark cloud or a rainbow might appear, so it’s best to never claim credit for something that hasn’t happened.

Cost of Living

An electricity bill credit of up to $500 will be available in 2023/24 for Pensioners, Commonwealth Seniors Health Card holders and other concession card holders, Recipients of Carer Allowance and Family Tax Benefit A and B, Veterans, and those eligible for existing State and Territory electricity concession schemes.

Increased bulk billing: Children under the age of 16, pensioners and other Commonwealth concession cardholders will have increased access to free healthcare under this measure, with bulk billing incentives being tripled for the most common consultations.

Low-cost loans will be available for energy-saving home upgrades, such as battery-ready solar panels, more modern appliances, and other energy efficiency improvements.

Superannuation

We already knew about the 15% tax increase on earnings above $3 million, which was announced earlier in the year.

Businesses will also be required to pay superannuation at the same time workers are paid. The benefit for investors is those contributions should compound faster. The previous pay deadline was quarterly, being 28 days after the quarter end. This change is to be implemented from 2026.

July 2023 will also see the end to the 50% reduction in annual minimum drawdowns for those over 65 now drawing on their superannuation.

Housing

Another one that filtered out pre budget was a change to eligibility for the home buyer guarantee. From 1 July 2023, it’s now available to more joint applicants e.g. friends, siblings and other family members under the First Home Guarantee and the Regional First Home Buyer Guarantee. Non-first home buyers who have not owned a property in the last ten years will also be eligible. The Family Home Guarantee is also expanding to include eligible borrowers who are single legal guardians of children such as aunts, uncles, and grandparents.

Social Security

Increase to income support payments: The fortnightly rate of JobSeeker, Austudy and Youth Allowance will be increased by $40 in September 2023. Eligibility for the higher rate of JobSeeker that is available to recipients aged 60+, and who have received the payment for 9 or more continuous months, will be expanded to those aged 55+. This payment will increase $92.10 per fortnight.

The maximum rates of Rent Assistance will increase by 15% in September 2023. This will provide recipients up to $31 extra per fortnight.

Tax

No major new tax changes were announced.

Stage 3 tax cuts will take effect from 1 July 2024, and there is no extension of the Low and Middle Income Tax Offset, which ended 30 June 2022.

The Government will increase the Medicare levy thresholds for singles, families and seniors or pensioners from 1 July 2022. This means low-income earners will be able to earn more income before paying the Medicare levy.

Aged Care

Increase to Home Care packages: As part of a package to improve the in-home aged care system, the Government will increase the number of Home Care packages by 9,500 in 2023/24. This may help reduce the wait time for individuals who are waiting for a package to be assigned to them.

The Government will also fund a wage increase for aged care workers, allocating $11.3 billion to provide an interim increase of 15 per cent to award wages for many aged care workers.

Small Business

Small businesses with an annual turnover of less than $50 million may receive an additional 20% deduction on spending that supports electrification and more efficient use of energy.

Up to $100,000 of total expenditure will be eligible for the incentive, with the maximum deduction being $20,000 per business. Eligible assets or upgrades will need to be first used or installed and ready for use between 1 July 2023 and 30 June 2024.

Small businesses with an annual turnover of less than $10 million will also be eligible to immediately deduct the full cost of eligible assets costing less than $20,000 for assets that are first used or installed ready for use between 1 July 2023 and 30 June 2024. Small businesses can instantly write off multiple assets as the $20,000 threshold will apply on a per asset basis.

Immigration

Unlikely to be widely acknowledged was net overseas migration for the 22/23 year increasing to 400,000 from 235,000 in the October 22 budget. With 2023/24 forecast to increase to 315,000 from 235,000. Adding people to the population has GDP benefits, but they also require somewhere to live. Dwelling approvals were falling into 2020 and there was only a brief spike in approvals during 2021, which came due to home builder incentives. Dwelling approvals are now back to near decade lows.

This material is provided for information only. No account has been taken of the objectives, financial situation or needs of any particular person or entity. Accordingly, to the extent that this material may constitute general financial product advice, investors should, before acting on the advice, consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation and needs. This is not an offer or recommendation to buy or sell securities or other financial products, nor a solicitation for deposits or other business, whether directly or indirectly.

March Quarter Review

Economic Overview

Inflation and interest rates remained points of interest across Q1, but towards the end of the quarter attention turned to the consequences of higher interest rates and what they might potentially break. Global growth appeared to be heading in the right direction, as rebounds in various purchasing managers’ indices and business surveys indicated positive sentiment. This was further boosted by China reopening and lower energy prices, however the March collapse of Silicon Valley Bank prompted concerns in the financial space and volatility in the banking sector. Geopolitics remained a factor, with the war in Ukraine ongoing and further tensions between the US and China. While inflation continued to ease across many economies, it remained relatively high in Q1, leaving central banks to tighten monetary policy further. Despite the late quarter sell off, there were positive returns in the major asset classes. The Australian market posted a fair gain, while global equity markets were up strongly for the quarter.

In the US, GDP grew at an annualised rate of 2.6% in Q4 2022, slightly less than initial estimates. Data published since the beginning of 2023 suggests that the US economy continued near that pace in Q1 2023, with real-time GDP tracking indicating 2.5% annualised. February CPI showed headline inflation falling to 6.0% year on year. This was the eighth consecutive monthly decline, down from 8.9% in June. Inflation is now dominated by shelter costs, these now account for over 70% of the increase in the CPI figure. The Federal Reserve raised rates 0.25% twice during Q1. The second increase arrived after the collapse of Silicon Valley Bank, where the Fed expressed confidence in the resilience of the banking system.

The US labour market remains resilient, February non-farm payrolls grew by a stronger-than expected 311,000, while average hourly earnings rose by 4.6% year on year, with unemployment sitting at 3.6%. There have been corporate layoffs in some sectors, notably technology, as companies are taking the opportunity to cut projects and eliminating staff they couldn’t afford to lose previously. Work trends also appear to be reverting to pre covid expectations. According to a Department of Labor survey 72.5% of businesses said their employees rarely or never worked from home in 2022, up from 60.1% in 2021. This means around 21 million more workers were on-site full time in 2022.

In the Eurozone, the European Central Bank raised interest rates by 0.5% in both February and March. Eurozone inflation was at a one year low in March, sitting at 6.9%, down from 8.5% in February. However, core inflation (excluding food and energy costs) rose to 5.7% from 5.6%. The flash purchasing managers’ index reached a 10-month high of 54.1 in March, although growth was fueled by the service sector with the manufacturing below 50 (above 50 = expansion). A week after the failure of Silicon Valley Bank, troubled Swiss investment bank Credit Suisse was bought by UBS in a deal brokered by the Swiss authorities. While there were some concerns, most quickly accepted Credit Suisse’s problems were contained. In France, plans to raise the retirement age from 62 to 64 saw widespread protests and President Macron’s government narrowly survived a no-confidence vote on the issue.

In the UK, quarterly GDP data showed the UK economy had not contracted in Q4 2022, contrary to expectations. As a result, the economy dodged a technical recession by avoiding two consecutive quarters of decline after Q3’s decline. Energy prices have fallen significantly, as the European energy crisis eased. The Bank of England’s Monetary Policy Committee voted to continue to raising interest rates moving upward by 0.25% in March to 4.25%, while leaving the door open to further tightening, if necessary, but expiring fixed rate mortgages may do some of this work. On the inflation front, headline CPI sat at 10.4%, with core CPI at 6.2% year on year for February. UK inflation proved stronger than expected, due to the resilience of the domestic economy. Composite PMI for March dropped slightly from 53.1 to 52.2, but remains in expansion territory, while consumer confidence continues to surprise to the upside. 

In Japan, 2022 GDP growth came in at a modest 1.1% after a 1% contraction in Q3 and a smaller than expected recovery in Q4. Like other economies Japan is still dealing with elevated inflation, albeit at a more modest rate of 4.3%, but this remains high in comparison to recent decades. Attention was still on the surprise December announcement by the Bank of Japan to allow the yields on long-dated government bonds to increase. In January, the BoJ bought $182 billion in bonds to defend their new yield cap. Contrary to expectation, rates were left on hold at the BoJ’s January policy meeting.

In China, US-China tensions resurfaced during the quarter following the shooting down of a Chinese weather (or spy) balloon in US airspace, but there was still optimism about the re-opening of the economy and a potential easing of regulatory pressure on the internet sector. Inflation has remained subdued, allowing the People’s Bank of China to maintain relaxed monetary policy. Excess savings accumulated during lockdown are expected to fuel a recovery via the services sector. This was reflected in the Services PMI reading, which rebounded to 55 in February. Despite strong potential for economic growth, China’s February CPI reading still came in below expectations, increasing only 1% year on year, while the producer price index stayed in deflation territory, falling 1.4%. In response, the PBOC announced a 0.25% cut to its reserve requirement ratio for banks in March.

In Emerging Markets, Brazil saw softening economic data and anti-government riots that damaged government buildings in January. India also saw economic data below consensus expectations. South Africa continues to suffer an ongoing electricity crisis, while it was also ‘grey-listed’ in February by the Financial Action Task Force given its slow progress implementing processes to combat money laundering and terrorist financing.

Back in Australia, data released in March showed GDP increasing by 0.5% for Q4 2022, with the economy growing by 2.7% year on year, showing the economy is still robust. Inflation remained elevated, Monthly CPI came in at 6.8% for the 12 months ending February 2023, down from 7.4% in January. The largest price increases were seen in housing, food, and transport. The savings rate fell to 4.5% in Q4 22, the lowest level since 2017 as interest payments increased. Despite elevated inflation, the RBA continued with 0.25% rate increases at its February and March meetings, noting that it expected inflation to moderate, but services and rent inflation remained high.

Despite the ongoing interest rate increases, some experts were scratching their heads as the housing market, specifically in Sydney appeared to do an abrupt turn during the second half of the quarter. While the national change in dwelling values was down -0.6% across the quarter according to CoreLogic, it was up 0.6% in March. Sydney doing most of the lifting, up 1.4% for the month, albeit still down -12.1% since April 22. Notably, Hobart and Canberra were the only capital markets not to stage any recovery, with Hobart down -12.9% for the year, -4% for the quarter and -0.9% for March. Canberra was down -8.1% for the year, -2% for the quarter and -0.5% for March.

Market Overview

Asset Class Returns

The following outlines the returns across the various asset classes to 31 March 2023.

Global sharemarket returns were strong in Q1, despite the fallout from the failures of Silicon Valley Bank and Credit Suisse. Both failures led to significant volatility in markets towards the end of Q1. The Australian market was more subdued, but still posted a decent return. Australian listed property began to stage a recovery in the first half of the quarter and was up over 10% at one point, but by the end of the quarter had given up most of its gains. Bond prices strengthened across Q1 as yields eased towards the end of the quarter. The 10-Year US Treasury yield started Q1 at 3.88% moving above 4% by end February, but dropped in March with banking concerns, ending the quarter at 3.48%. US 2-year yields also moved higher until March, then slipped back, ending Q1 at 4.06%. In the UK, the 10-year yield fell from 3.67% to 3.49%, while the Australian 10-year yield fell from 4.04% to 3.30%.

In the US, the S&P 500 was up 7.5% for the quarter, albeit down from its January peak, with selloffs in February and early March, before a late quarter rally to recover some earlier gains. The Russell 2000 small-cap index saw the most pain from the banking crisis, due to a higher financial sector weighting. While the Russell 2000 finished up 2.75% in Q1, it was up almost 14% at the beginning of February. Despite the banking and financial sector issues, the energy and healthcare sectors struggled the most over the quarter, while communication services and the technology sectors were both up more than 20%.

The Silicon Valley Bank (SVB) failure was the most notable issue in the US during the quarter. While there were concerns about contagion, SVB was more of an isolated issue with a narrow customer base and poor risk management. SVB took large deposits from start-up tech companies and used these deposits to purchase longer term debt. The sharp increase in interest rates over the past year meant the value of these assets declined significantly. With the tech sector under stress, many depositors began to withdraw their funds. SVB was forced to sell some of its long-term debt at a significant loss, and word began to spread, resulting in a bank run. Because many of its customers had abnormally large deposits, above the government insurance mark of $250k, it explains the panic, although the US administration later said it would honour all deposits.

Eurozone shares were the best performer of the major regions despite banking sector volatility, with the French and German markets posting double digit gains. One of Europe’s biggest concerns over the past year was energy security due to the Russian invasion of Ukraine, but a very mild winter and a significant emphasis on finding new sources of natural gas has helped restore confidence. Technology, consumer discretionary and communication services sectors were the strongest performers, while real estate struggled due to higher financing costs and weaker occupancy rates. Despite the troubles with Credit Suisse, the eurozone financials sector still managed gains for the quarter as the problem was viewed as being quickly contained.

UK shares posted modest gains over Q1, with strong moves across January and February, but global banking concerns saw the UK market sell off sharply in early March, without the late March recovery rally seen in other markets. Economically sensitive areas, such as consumer discretionary, outperformed in line with other markets. This reflected a strong recovery in domestically focused areas and hopes central banks may be able to cut interest rates in late 2023. As with other markets, real estate was the worst performing sector. Large companies held up, with smaller companies losing ground.

In Japan, shares rose strongly in Q1 with the Nikkei index up 9%. Quarterly earnings results announced across the late January to mid February period were mixed. Exporters had a difficult time due to yen appreciation during Q4 2022, while a slowdown in production mainly affecting the technology sector. Domestic focused companies recorded better than expected sales numbers, but suffered from cost increases. The Silicon Valley Bank collapse and the bailout of Credit Suisse by UBS dragged the market lower, with Japanese financial stocks hit hard, but the broader market almost recovered by the end of the quarter.

Asia (ex-Japan) and Emerging markets were positive across Q1 with the new year bringing renewed optimism about the re-opening of China’s economy. Chinese shares saw robust gains in January, but were mostly flat for the rest of Q1. The strongest gains came from Taiwan, Singapore, the Czech Republic and Mexico. India saw negative returns, as Adani Group was hit with allegations of fraud and share price manipulation early in the quarter, investors also soured on India as economic growth stalled. While emerging markets posted positive returns over the quarter, the broader index still lagged the developed market MSCI World Index.

The Australian market (All Ords Accumulation) was up 3.61% in Q1 and strongly in January, but relinquished most of those early gains as concerns around banking grabbed attention in March. As in many other developed markets, consumer discretionary was the best performing sector, up over 10%, followed by communication services and consumer staples. In fact, most sectors posted healthy gains, higher than the index itself, with the only negative sectors in Q1 being energy and financials. Financials were down -2.69%, with their heavy weighting being the biggest drag on ASX performance for the quarter.

This material is provided for information only. No account has been taken of the objectives, financial situation or needs of any particular person or entity. Accordingly, to the extent that this material may constitute general financial product advice, investors should, before acting on the advice, consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation and needs. This is not an offer or recommendation to buy or sell securities or other financial products, nor a solicitation for deposits or other business, whether directly or indirectly.

December Quarter Review

Economic Overview

Interest rates and inflation were again major themes in Q4, as the US Federal Reserve delivered a hawkish message to round out the year following its December meeting. This capped off a year dominated by inflation. Inflation figures in many developed economies hit the highest levels since the early 80’s. The high figures saw some very aggressive monetary policy in response, but there were signs the hawkish messages and aggressive rate moves may have started to have their intended effect. Inflation appeared to cool in some countries towards the end of 2022, most notably in the US. Financial markets showed reasonable performance in Q4, the ASX All Ords notched a strong gain while global markets were also up, however it wasn’t enough to offset a negative 2022 in both cases.

In the US, Q3 GDP figures released in December came in at 3.2%. This was stronger than estimates, and a bounce back after two straight quarters of contraction. Inflation remains elevated, coming in at 7.1% year on year in November, but this was down from 7.7% in October. Unemployment remains at 3.7% with 263,000 jobs added in November for a total of 4.3 million net new jobs ending November, but there are still 1.7 job vacancies for every person looking, ensuring hiring remains a challenge. Consumer spending has underpinned the economic recovery following the pandemic, but retail sales in the US declined 0.6% month-over-month in November of 2022. The biggest decline seen in 2022. The Fed’s final rate hike of the year was pared back to a 0.5% increase, after four consecutive 0.75% increases. Given the Fed’s late year comments, it’s expected more rate hikes will come in 2023. Real-time tracking estimates for Q4 growth indicate expansion around 2.7%, based on late December data.

In the Eurozone, inflation fell to 10.1% in November from 10.6% in October. The ECB raised interest rates by 0.5% in December, slowing from the previous 0.75% hikes. This brought the policy rate to 2%. ECB President Christine Lagarde also warn that the central bank was “not done” on this front. The Eurozone economy grew by 0.3% quarter-on-quarter in Q3, slowing from 0.8% in Q2. The composite purchasing managers’ index PMI for December was 48.8, up from 47.8 in November, but a reading below 50 still indicates contraction. The positive, for a region suffering an energy crisis, was seeing gas prices fall. Unseasonably mild weather for the period helped reduce gas cost pressure.

In the UK, a new quarter meant another new Prime Minister. Rishi Sunak was appointed leader of the Conservative Party, making him the new UK Prime Minister. Sunak’s prior experience as chancellor, along with the abandonment of policies announced in the September “mini-budget” by the previous leadership team helped to stabilise UK markets, which, along with the pound, had been in chaos due to the proposed tax cuts funded by borrowing. New chancellor Jeremy Hunt promised the country would tighten its belt in response. The Bank of England increased rates as anticipated, by 0.75% in November and 0.5% in December. The final inflation figure for the quarter sat at 10.7%, down 0.4% from the previous month.

In Japan, The Bank of Japan announced a change in yield control policy. Essentially, they are no longer against increasing yields on long-dated government bonds. This was viewed as significant by global investors. Japan has a reputation for being the only developed economy with very loose monetary policy. Bank governor, Haruhiko Kuroda, denied the move represented a tightening of policy, but markets disagreed. The Yen strengthened by 4% immediately after the announcement and Japanese stocks experienced sharp falls. Data showed that inflation hit 3.7%, the highest level since the 1980’s. The government put in place an additional fiscal package in Q4, which aims to bolster a domestic recovery in 2023.

In China, early in Q4 it was announced Premier Xi Jinping would remain in power for another five years, as the “Zero Covid” policy looked to be extended. Both were seen as negatives, however by November there was a reversal by the Chinese government on the Covid front. Following continual public unrest at lockdown restrictions, policy makers announced the immediate removal of the strictest restrictions. Despite the initial (and expected) spike in cases as a result in December, it was announced borders would reopen to international visitors in January 2023. There was also an easing of geopolitical tensions, as both Xi Jinping and US President, Joe Biden, expressing that they would like to improve relations. As expected, there was a decline in both manufacturing and services output during the period.

In Emerging Markets, the weaker US dollar during Q4 was supportive, but optimism faded in December when the US Fed re-iterated its commitment to fighting inflation. In Turkey the central bank loosened monetary policy as interest rates were cut to 9% in November, but in a country where inflation topped 85% in October, the central bank announced that would be the end of the current easing cycle. Macroeconomic data in India and Taiwan was mixed, while policy uncertainty clouded the outlook in Brazil after President Lula’s election in October.

Back in Australia, data released in December showed GDP increasing by 0.6% for Q3 2022, with the economy growing by 5.9% year on year, reflecting the economy is quite strong. Household consumption accounts for around 55% of GDP, but household consumption growth is falling. The savings rate fell to 6.9%, some called this a normalisation, as the savings rate is now back around pre-covid levels. All this should be expected, as monetary policy from the RBA has been quite aggressive. While interest rates are still historically low, they have moved sharply higher from a record low base.

On that front, annual inflation for Q3 came in at 7.3%, the highest inflation reading since 1990. Despite increasing inflation, the RBA slowed its rate increases from 0.5% as they’ve been each month in Q3, to 0.25% for each month of Q4. Even so, that totalled eight consecutive interest rate rises, which brought the cash rate to 3.10%. The quick upward move from 0.1% was again felt in the property market. In its December statement, the RBA said it expected inflation to increase in the months ahead, but decline next year.

Rate increases were being felt in the real estate market, according to data from Corelogic. As of December 31 the combined capital city index was down -3.3% for the quarter and -8.6% from the peak seen in mid May 2022, which came two weeks after the RBA’s first interest rate rise. Sydney was down -12.7%, Melbourne -8.3%, Brisbane -9.2%, and Hobart -9.3% since peak. While Adelaide -1.3% and Perth -0.6% were more resilient. The combined regional index was down -6.6% since its peak in June.

Market Overview

Asset Class Returns

The following outlines the returns across the various asset classes to 31 December 2022.

Global sharemarkets were positive in Q4, with the Australian market quite strong, while Australian listed property attempted to recover lost ground. Asian markets were boosted by China’s relaxation of its zero-Covid policy, while European equities also advanced strongly and were the strongest performer of the major regions. Overall, it was still a negative year, despite the better performance in the second half and final quarter.  Bond prices were more subdued in Q4 as yields settled into a tighter range than seen earlier in the year. The 10-Year US Treasury yield finished almost flat for Q3, moving from 3.83% to 3.88%, with 2-year yields rising from 4.22% to 4.42%. In the UK, the 10-year yield slipped from 4.09% to 3.67%, while the Australian 10-year yield moved from 3.91% to 4.04%.

US shares saw mid-single-digit growth in October and November, but December saw a sell off with the markets suffering in the last few weeks of the quarter. Most sectors rose over the quarter, with a number climbing significantly. Energy stocks posted especially strong gains, as sector heavyweights Exxon and Chevron posted record profits in the quarter. Consumer discretionary was a notable exception, with Tesla’s ongoing decline a major influence. S&P 500 earnings grew at a projected 8%, boosted by significant earnings growth in the energy sector. Excluding energy, S&P 500 earnings fell by 1.8%. While company revenues were increasing, higher input and interest costs have put pressure on margins.

Eurozone shares saw strong gains in Q4, outperforming other regions. Economically sensitive areas like energy, financials, industrials and consumer discretionary were the big winners, while more defensive areas such as consumer staples lagged the wider market’s advance. Gains were supported by hopes that inflation may be peaking in Europe, as well as in the US. Tailwinds also emerged as milder weather eased concerns over energy shortages. French and German markets saw gains of 12.8% and 14.8% respectively.

UK shares saw strong gains in Q4, helped by the appointment of a new PM and chancellor who steadied the ship and helped the UK move on from the crisis of the previous team. The FTSE 100 and the FTSE All-Share Index were both up over 8% for the quarter. By sector, there were very strong gains from basic materials 16.8%, healthcare 12.4%, utilities 12.4%, consumer discretionary 11.8%. The only notable laggard was telecommunications, down nearly 10%.

In Japan, the market saw gains in October and November before declining in December. All up, the total return for Q4 remained positive, at 3.3% in yen terms. Most Japanese companies reported Q3 earnings in November. Results were quite strong and stronger than expected, particularly for larger companies benefiting from yen weakness. The level of confidence among management teams was highlighted by a record level of share buybacks being announced.

Asia (ex-Japan) and Emerging markets, Chinese shares were quite volatile as the quarter began with a sharp sell-off in Chinese and Hong Kong markets as investors digested the news of Xi Jinping would remaining in power and ongoing “Zero Covid” policy. When the Chinese government relented on Covid restrictions the Shanghai Composite and Hang Seng saw significant rallies through to the end of December. In contrast, Taiwan shares had a strong move upward in November, but flatlined over higher US interest rates and lower demand for electronic goods, one of Taiwan’s biggest exports. Thailand, the Philippines and Singapore were also strongly positive. The Middle East markets underperformed, impacted by weaker energy prices. Qatar and Saudi Arabia being major laggards. Indonesia was also negative, while India struggled as macroeconomic data was mixed. Poland and Hungary rebounded following months of underperformance due to the war in Ukraine.

The Australian market (All Ords Accumulation) was up nearly 9% in Q4 due to a strong rally through October and November, but spent most of December going backwards, as US interest rate concerns flared again. Utilities were the strongest performer, up over 26%, and jumping significantly in response to a takeover offer for Origin Energy in November. Materials were also a strong performer, up nearly 15%, as the bigger miners shrugged off the December sell off seen across the broader index. Consumer discretionary and consumer staples were flat, while industrials were up 6%.

This material is provided for information only. No account has been taken of the objectives, financial situation or needs of any particular person or entity. Accordingly, to the extent that this material may constitute general financial product advice, investors should, before acting on the advice, consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation and needs. This is not an offer or recommendation to buy or sell securities or other financial products, nor a solicitation for deposits or other business, whether directly or indirectly.

September Quarter Review

Economic Overview

The major theme from Q3 was the Central Bank resolve to dampen inflation. Unfortunately, the only tool in Central Bank arsenals are interest rate increases, something that continues to offend financial markets. There were large rate increases by the US Federal Reserve and Australia’s Reserve Bank in Q3, with the European Central Bank also joining the party with two large increases. Energy remained an issue, with the prospect of the war in Ukraine now becoming a longer-term battle, as Ukraine’s resistance and Russia’s inability to hold territory was in contrast to early expectations. Financial markets were slightly improved in Q3 compared to Q2, with high volatility. The ASX All Ords notched a gain and global sharemarkets managed a slightly positive return in Australian dollar terms, albeit bond markets again slipped.

In the US, annual inflation came in at 8.3% in August, slightly down on the 8.5% of July, however the Federal Reserve’s preferred inflation measure (personal consumption expenditures index) increased in August year on year from 4.7% to 4.9%. GDP data fell by -0.6% year on year in Q2 after a -1.6% decline in Q1 confirming the US economy went into a technical recession, with increasing inventories and lower business investment the main detractors from growth. This was in contrast to other more resilient data points. August non-farm payrolls showed 315,000 new jobs added for the month, with 3.5 million new jobs created in 2022. The Flash U.S. Purchasing Managers’ Index inched higher to 51.8 in September from 51.5 in August, slightly ahead of market forecasts.

With some mixed data on growth, there were hopes rate cuts may appear in 2023. This was scuttled at the Jackson Hole summit of central bankers in August, as the Federal Reserve highlighted it was committed to fighting inflation. The Fed raised the federal funds rate by 0.75% to 3.25% in September, the third consecutive increase.

Household debt is the other question with rising rates. Data from Q2 showed debt repayments as a percent of disposable personal income, increased to 9.5%. Still well below the high point of 13.2% in late 2007. Excess savings accumulated during the pandemic were estimated at $2.26 trillion dollars, with higher prices in the consumer space this has seen a drop in excess savings of around $.40 trillion.

In the Eurozone, the Central Bank increased rates in July and September, shifting the deposit rate to 0.75% and refinancing rate to 1.25%. Annual inflation was estimated at 10% in September, up from 9.1% in August with energy costs the largest contributor. This is in contrast to the US, where inflation is more evenly spread between energy, services and goods. Nord Stream 1, the main gas pipeline from Russia was closed for maintenance in July. Russia then shut it down again in early September. This put pressure on power generators, forcing them to buy natural gas from higher cost sources. It also increased worries over energy shortages this winter, while helping send the euro to a 20-year low against the US dollar.

Eurozone GDP grew by 0.7% quarter-on-quarter in Q2, but there were signs of a weakening economy. The flash composite purchasing managers’ index (PMI) for September came in at 48.2, a third consecutive month below 50. Below 50 indicates contraction, above 50 signals expansion.

In the UK, the key event for the quarter was the election of Liz Truss as new Conservative Party leader and UK Prime Minister. The new government immediately unveiled a fiscal package in September which was poorly received by markets and sent the pound to an all-time low against the US dollar. Pound weakness had already been a factor during the quarter, especially as the US Fed warned it would keep raising interest rates. On the matter of rate rises, the Bank of England raised its key interest rate for the seventh consecutive time in September, taking it to 2.25%, the highest level since 2008. In sobering news, Goldman Sachs forecast UK inflation could hit 22% in 2023 if wholesale gas and electricity prices continue to spike over winter.

In Japan, the Bank of Japan held rates, widening the interest rate gap between Japan the US. The gap has been a major factor in the weakening of the yen in 2022. In late September this prompted an intervention by the Ministry of Finance in the currency market when the yen was rapidly depreciating towards 146 against the US dollar. This was the first intervention in support of the yen since 1998, but by the end of September, the yen had already weakened again sitting at 144.6 to the US dollar. GDP estimates showed a quarter-on-quarter annualised growth rate of 2.2%. This was slightly below expectations, but it was seen as a positive with some resilience in consumption and capital expenditure.  Finally, inflation continued to edge up with the headline rate reaching 3.0%, and the core rate, excluding fresh food and energy, at 1.6%.

In China, growth continued to slow with Q2 data showing a 2.6% fall in GDP quarter on quarter, reflecting the ongoing impact of strict covid lockdowns. The Caixin China General Services PMI fell to a three-month low of 53.0 in August 2022, due to another wave of covid infections and energy shortages from the drought. The heatwave hit supply chains across the industrial heartlands.  In provinces that rely heavily on hydropower, low river flows resulted in the government instructing factories to shut in an attempt to conserve energy. There was growth in the private sector, with services continuing to outperform manufacturing. Expectations for 2022 GDP growth are sharply down at 2.8%, a significant drop from 8.1% growth in 2021. The People’s Bank of China eased rates by 0.15% in August but held in September.

In Emerging Markets, the continuing strength of the US dollar was a worry and there were concerns over the growth-sensitive north Asian markets, such as South Korea and Taiwan, as the outlook for global trade deteriorated. Falling commodity prices weighed in some countries, while concerns about reliable power supplies were an issue from the Philippines to South Africa, with South Africa dealing with rolling blackouts killing business confidence. Finally, if you’re having some concerns about inflation, spare a thought for the Turks. Turkey’s inflation is running above 80%, but the central bank still cut interest rates twice during the quarter, with the economy growing strongly.

Back in Australia, data released in September showed GDP increasing by 0.9% for Q2 2022, with the economy growing by 3.9% year on year, the strongest year on year figure for a decade. The savings rate fell to 8.7%, as spending outpaced growth in income, but the savings rate is still slightly above pre-covid levels. As with many other countries, increasing energy prices continued to be a concern as the Australian Competition and Consumer Commission suggested eastern Australia faces a gas shortfall in 2023.

Interest rates were again a focus in Q3. Annual inflation for Q2 came in at 6.1%, the highest inflation reading since 2001. In response, the RBA increased rates by 0.5% in each month during the quarter, making it five consecutive interest rate increases, and bringing the cash rate to 2.35%. The quick upward move from 0.1% was again felt in the property market. According to CoreLogic, the combined capital index was down -4.3% for the quarter, Sydney at -6.1%, and Hobart at -4.5% suffering the largest falls. While the combined regional index was down -3.6% for the quarter.

Market Overview

Asset Class Returns

The following outlines the returns across the various asset classes to 30 September 2022:

Global sharemarkets were a mixed bag in Q3, but the falling Australian dollar offered some protection against global falls. Markets started quite positively and rallied until mid-August on the belief inflation data and the US Federal Reserve might be more accommodating on interest rates. As noted earlier, it was the Jackson Hole summit where markets reacted poorly to blunt comments from Fed Chair Jerome Powell and spent the rest of Q3 heading back to where they began the quarter. Bond prices also continued to weaken as rates increased. The 10-Year US Treasury yield moved from 2.98%, finishing Q3 at 3.83%, with 2-year yields rising from 2.92% to 4.22%. In the UK, the 10-year yield moved from 2.23% to 4.09%, while the Australian 10-year yield moved from 3.66% to 3.91%. Many 10-year yields were falling throughout July before setting off higher again across August and September, reaching yields not seen for over a decade. Something for new bond investors to look forward to.

US shares fell in Q3, with the communication services sector, being telecoms and media, among the weakest sectors, along with real estate and materials. The consumer discretionary and energy sectors proved the most resilient. The S&P 500 large-cap index dipped into bear market territory again in the quarter, relinquishing the strong bounce off the June lows finishing down -4.9%. The small-cap Russell 2000 index lost 2.2% for the third quarter. Returns in the US have, like in many other countries, favoured value companies throughout 2022.

Eurozone shares saw further sharp falls in Q3 amid the ongoing energy crisis, rising inflation, and ultimately fears about economic growth. Every sector saw negative returns, with the steepest falls for communication services, healthcare and real estate which has been pressured by rising bond yields. The German DAX was off 5.2% and the French CAC 40 down 2.7% with the majority of the falls in the final weeks of the quarter. Meanwhile, pharmaceutical companies were hit over potential liabilities related to US litigation around the heartburn drug Zantac.

UK shares fell in Q3 with the wider market down 4.5% and the FTSE 100 down 3.85%. Large multi-national consumer staples and energy companies were the outperformers. These areas are seen as better placed to cope with a potentially stagflationary environment, where growth is low, and inflation is increasing. The strong US dollar was a positive in these areas of the market, given these companies see a large part of their revenues from overseas. In contrast, the potential impact of rising energy bills on consumer discretionary spending weighed heavily on retailers, travel and leisure, home construction and anything with a domestic focus.

In Japan, after rising through July and August, the Japanese share market followed global equity markets lower in September, with the Nikkei down 1.72% for the quarter. Ignoring economic data, the main influence on Japanese shares came from the results announcements for Q2, which finished in August. Although profit eased from Q1, overall results were ahead of expectations and despite increasing costs, profit margins appear to have remained resilient.

Asia (ex-Japan) and Emerging markets shares were a mixed bag depending on the influence. Most Asian sharemarkets were weaker, with China the weakest Asian index due to more global concerns over rates and inflation, tensions with Taiwan, and the increasing spread of covid and the potential for further harsh lockdowns. In Hong Kong, share prices were sharply down as investors continued to sell riskier assets, heading to the perceived safety of government bonds given the threat of interest rate hikes and recession.  India and Indonesia saw gains, but they were tempered by rate concerns toward the end of the quarter. Poland, Hungary, and the Czech Republic all struggled due to the war and energy crisis. Brazil was one of the stronger performers as data showed the economy growing strongly and CPI inflation cooling.

The Australian market (All Ords Accumulation) was up for the quarter, though gave up most of its early gains in the final weeks as US interest rate concerns flared again. Consumer discretionary, consumer staples and industrials saw mild falls, but the major underperformer was utilities, off -13%. Financials finished flat, with their weighting probably keeping the market steady, while energy notched a small gain.

The Value of Value

Generally, when we’re discussing investment returns or how portfolios perform, we stick to using various market indices as the basis of what we’re discussing. It’s often easier to get a grasp on because it’s standard and it aligns with what is quoted in the media. The other reason is, if an investor can just sit and get the market return from these various indices, such as the ASX All Ords S&P 500 or MSCI World, it’s a win. They’ll likely do better than investors who spend their time chasing hot funds year to year or trying to time their entry and exit every time there’s a scare.

We also allocate portfolios beyond just the market, to specifically account for value shares. It’s only a small consolation, but over the last year, one of the least punished areas of the market have been value shares. The following table shows the local and global markets against respective value funds and respective funds with a 30% allocation to value.

As noted, it’s only a small consolation in a rough year, however the interesting thing about value shares is they’ve shown strong performance characteristics going through periods of high inflation. The mid 1970’s was one such period. Investors certainly still had to tolerate some wild falls as inflation spiked, but an allocation to value proved rewarding to those that held on. It outperformed the major index, being the S&P 500, while also outpacing inflation.

The early 1980’s in Australia is another example (the whole 1980’s could be used) where value performed better than the wider market during a rough period where inflation spiked.

There are a few eye-catching numbers there. We’re certainly not suggesting if inflation moderates that investors will be looking at 100% returns in value shares, but it’s important to keep in mind market recoveries can be swift and certain market factors, like value, can potentially see even stronger moves. This is compensation for the extra risk of holding them. The market index is always a great start for investors, but allocations to other areas can prove rewarding. While it’s not a guarantee, having allocation to value has helped offset some rough inflationary periods. The idea being that having earnings now in a value company is more valuable than future earnings in a growth company.

The final thing to remember is while there are always a lot of scares around what inflation will do to the sharemarket, everything gets priced in, and the market moves on. This famous magazine cover was published in the US five months before the period above began in 1980. Despite the scare, there was certainly no death of equities and inflation didn’t destroy the sharemarket!

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This material is provided for information only. No account has been taken of the objectives, financial situation or needs of any particular person or entity. Accordingly, to the extent that this material may constitute general financial product advice, investors should, before acting on the advice, consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation and needs. This is not an offer or recommendation to buy or sell securities or other financial products, nor a solicitation for deposits or other business, whether directly or indirectly.

June Quarter Review

Economic Overview

The major theme from Q2 was the swift upward movement of interest rates to combat inflation, along with the implications for economies, sharemarkets and bond markets. Two of the three Central Banks that may have been considered laggards up to this point, the US Federal Reserve and Australia’s Reserve Bank, appeared to be making up for lost time in Q2. Both moved aggressively, with sharp increases in rates during the quarter. Energy also came into focus, as the war in Ukraine continued and the thinking turned to potential gas shortages in Europe. Any remaining euphoria from 2021 left financial markets in Q2, with the quarter being poor for both sharemarkets and bond markets. The cost of living was noted to be a major issue across most economies.

In the US, the focus narrowed in on inflation and the likely response from the Federal Reserve after a 0.25% increase in March. Annual US inflation, as measured by the consumer price index (CPI), came in at 8.6% in May, the largest increase since the period ending December 1981. The food index increased 10.1% annually, which was the first double digit increase since March 1981. Expectations were for 0.5% rate increases in May and June, but with inflation becoming a bigger issue, the Federal Reserve increased rates by 0.5% in May and 0.75% in June, bringing the federal funds rate to 1.58%.

The Federal Reserve signalled more rate rises were to come, but also admitted it has a challenge to bring inflation down and not cause a recession. The US economy still appears robust, with the job market continuing to be tight. Unemployment is at 3.6% with an estimated 1.9 job vacancies for every person looking for work, but there are signs of a slowdown. Flash US Manufacturing Purchasing Managers Index (PMI) fell from 57 in May to 52.4 in June, indicating the slowest growth in factory activity in two years.

In the Eurozone, ongoing disruption to German gas supplies due to the war in Ukraine saw Germany move to phase two of its energy emergency plan. Phase three would involve rationing gas to industrial users, and possibly households. The war has seen the largest displacement of European citizens since World War 2. Prior to the war, the EU faced headwinds due to supply-chain disruptions, and goods inflation. The war triggered sharp increases in energy and commodity prices, especially those heavily linked to Russian trade. Positively, job growth continued on its post-pandemic stable trajectory.

A Eurostat inflation estimate for June stood at 8.6% in Europe, up from 8.1% in May, with energy being the largest factor in the rise. In its June policy decision release, the ECB noted it would increase rates 0.25% in July, with another move expected in September. Concerns over the cost of living and possibility of recession saw the European consumer confidence reading fall to -23.6 in June, the lowest level since the early stages of the pandemic. Given the ongoing war and the fact its key rate was already negative, the ECB has a big challenge ahead with potential stagflation, where economic growth stalls as inflation increases.

In the UK, The Bank of England made two consecutive 0.25% hikes to take the Bank Rate to 1.25%, as it continued to warn of higher inflation. April’s CPI came in at 9% with May’s at 9.1%, driven by a significant increase in energy prices. This was the highest annual figure since the current set of UK National stats began in January 1997, with modelling suggesting it was likely the highest figure since 1982. The Bank of England forecasts peak inflation to be 10%, before falling back to 6% by the end of 2022. UK GDP is estimated to have grown by 0.8% in Q1. UK chancellor Rishi Sunak unveiled further measures to help households offset higher energy bills.

In Japan, the yen weakened significantly against the US dollar, breaching the 130 level for the first time in two decades. Comments from the US Federal Reserve pointed to a widening interest rate differential with Japan materialising earlier than expected. Despite some pressure to address interest rates, the Bank of Japan didn’t move, and policy remained unchanged. With the rising cost of living a global issue, in Japan the public have thus far remained relatively unscathed. Inflation numbers released in May, showed core CPI (excluding fresh food) jumped to 2.1%. Data released toward the end of Q2 showed worldwide production at Japanese automakers declined for a third consecutive month, with poor supply of parts from China an issue.

In China, there were signs of improvement during Q2 after a tough Q1. Strict Covid-19 protocols enacted by the government resulted in lockdowns in several major cities, leading to the closure of multiple manufacturing factories. Shanghai, China’s largest city by gross production, was locked down tightly while Beijing and other parts of the country also imposed varying levels of quarantine to contain the worst outbreak since the pandemic began. Manufacturing PMI for China rose to 49.6 in May from April’s 26-month low of 47.4, amid an easing of COVID-19 restrictions. The government have taken further steps to encourage growth, lowering a key interest rate for long–term loans as well as issuing a statement of intent to provide clarity on regulation in the technology sector.

In Emerging Markets, it was a mixed bag, often depending on commodities produced. Net industrial metal exporters, such as South Africa, Brazil and Peru, struggled due to fears of a lack of demand for materials from Chinese factories, and the copper price spending the majority of the quarter in a downtrend. Net energy exporters, such as Kuwait, Qatar and Saudi Arabia, fared much better. Hungary and Poland struggled due to proximity to Ukraine, with Poland hit hard following Russia’s decision to restrict energy supply. Central banks in both countries increased policy tightening, while the Hungarian government announced windfall taxes on banks and other large private companies.

Back in Australia, data released in June showed GDP increasing by 0.8% for Q1 2022, with year-on-year growth at 3.3%. The savings rate was at 11.4%, still well above pre-covid levels. The biggest event for the quarter was the election, with the Labor party forming a majority government. However, there was little time for a honeymoon as soaring east coast energy prices posed an immediate issue for households and businesses.

The other big news in Q2 was interest rates. After reaffirming in March that “the Board will not increase the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range”, inflation for Q1 came in at 5.1% in data released in late April. A few days later at their May meeting, the RBA increased the cash rate by 0.35%. The board noted “resilience of the Australian economy is particularly evident in the labour market”. The RBA board followed with another 0.5% increase in June. As expected, the property market quickly felt the rate increases. CoreLogic’s 5 Capital City Index saw a -0.9% fall for Q2, with the most expensive markets, Sydney down -2.8%, and Melbourne down -1.8%, the big drags.

Market Overview

Asset Class Returns

The following outlines the returns across the various asset classes to 30 June 2022.

Global sharemarkets continued their poor performance in Q2 as they priced in the reality of rising interest rates. This also saw bond prices continue to face headwinds as rates moved upward (when rates increase bond prices fall, when rates fall bond prices rise). The 10-Year US Treasury yield moved from 2.35%, finishing Q2 at 2.98%, with 2-year yields rising from 2.33% to 2.92%. In the UK, the 10-year yield moved from 1.61% to 2.23%, while the Australian 10-year yield moved from 2.84% to 3.66%. All 10-year yields saw much higher peaks in mid-June, before the market started considering the potential for recessions if Central Banks misstep and the prospect rates may not increase as much as expected.

US shares were negative in Q2 with investors focused on inflation and the response from the Federal Reserve. Declines hit all sectors, although consumer staples and utilities remained the most resilient. There were dramatic declines for some stocks, most notably in the media & entertainment and auto sectors, Disney was down 31% and General Motors 29%, for the quarter. After 2021 being a stellar year for earnings growth, the estimated earnings growth rate for the S&P 500 in Q2 was 4.1%, that would be the lowest since Q4 2020 at 3.8%.

Eurozone shares struggled. Hope for a resolution or ceasefire in Ukraine faded during the quarter, as early talks failed to yield any significant agreement. Top performing sectors included energy and communication services while information technology and real estate experienced sharp falls. Despite a high exposure to financials and energy sectors and a relative lack of technology names, the French and German markets saw losses of -11.32% and -11.29% respectively.

UK shares were again more resilient than most of their global counterparts, although the large cap FTSE 100 saw a 4.5% fall for Q2, but again smaller areas of the market suffered double digit falls. By sector, the positives were healthcare 5.86%, telecommunications 3.08%, energy 1.55% and consumer staples 1.23%. Consumer discretionary sectors, such as retailers and housebuilders, performed particularly poorly. This was in line with many other developed markets seeing high levels of inflation.

Japanese shares were negative over the quarter, with the Nikkei 225 down 5%, with the bulk of companies reporting results in May. With the current macro environment, there were few positive surprises, and some companies kept their forecasts for the coming year quite conservative. However, the tone of results and guidance was still better than expected. Chipmakers Tokyo Electron and Advantest were punished in June, while Kansai Electric was up 16% for the quarter as the mood toward nuclear energy softened due to the ongoing energy crisis.

Asia (ex-Japan) and Emerging markets shares were also sold off in Q2, albeit with emerging markets being one of the better performers in Australian dollar terms, down -3.3%. South Korea struggled, with financials, technology and energy companies badly hit amid fears of a recession. Shares in Taiwan were also significantly lower on fears rising inflation and supply chain problems would weaken demand for technology products. Indian shares also declined over the quarter as global volatility, rising inflation and soaring energy prices weakened investor sentiment. China was the only emerging market to generate a positive return over the quarter.

The Australian market (All Ords Accumulation) was up for April, but sold off heavily in May and June with the RBA’s interest rate announcements, along with global factors weighing. All Ords falls almost mimicked those of the Financials market sector as there were fears a housing slowdown would put pressure on earnings for Australia’s big four banks, though banking figures dismissed this toward the end of the quarter, suggesting they were well provisioned to deal with any issues and Australians were still sitting on significant levels of cash. Other sector weakness was seen in Consumer Discretionary and Information Technology, Materials and Real Estate. Utilities and Energy managed small gains.

Finally, there were eyebrows raised about some of the newer inclusions to the ASX 200. The lithium explorers who’d previously been flying, such as Core Lithium and Lake Resources, found themselves with a market capitalisation large enough to be included in the major benchmark and were promptly sold off heavily on inclusion. Lake fell 55% in the week after inclusion and Core fell 30%. Battery metal companies have been booming and busting for several years now, showing as volatile as markets can be, hot sectors can do a 180 flip at a much faster pace.

Where to From Here?

Whether you want to call the last quarter “repricing”, “selling off” or “losing”, the result is still the same: it’s not nice, but it’s nothing new. Markets have a habit of panicking first and asking questions later. That means returns never come in a straight line and at various points in time we’ll see losses in our portfolios. If you’re measuring by the end of June 2022, you will see losses, the reality is the market has already moved on. In the subsequent days, the ASX is up over 2% and the US markets are up over 3%. Will that last, continue or go into reverse?

We don’t know, but we’ve taken a look back in time to see what bad starts to the year since 1980 look like and what followed. We’ve looked at both Australian and Global shares. In some instances, while one market fell in the first half of the year (H1), the other didn’t, so it’s greyed out, and we had no need to look at the second half (H2).

It’s not particularly conclusive because it also includes three anomalies where the years where quite torrid for notable reasons. One, being a gulf war. Two, being the aftermath of a terrorist attack, the leadup to another gulf war and the end of the dotcom bubble. And three, a major global financial crisis in 2008. Are we currently in such torrid times? That depends on who you ask, but excluding those markets, there have tended to be bounce backs in the second half of the year after a poor start, 1994 being the outlier.

For US shares (using the S&P 500) we have seen one of the poorest starts to the year since the 1960’s. Since 1960 there have only been two first half losses in the magnitude of 2022’s, those were in 1962 which saw a -22.28% fall and 1970 which saw a 19.43% fall. What followed? In 1962 it was a 17.44% recovery and in 1970 it was a 29.11% recovery.

We don’t know what happens next, but we do know as shares sell off, historically, expected returns are higher. What we do know is shares and bonds are either cheaper than they were or now present an increased opportunity for yield. For long-term investors, there are mixed signals. There is still pent up demand, and a huge demand for labour, but weakening consumer confidence. There is talk of recession, but the economy spends most of the time in expansion, so it’s ultimately better to invest for growth.

Returns never present themselves in a neatly wrapped box. The risk, or price we pay, is the volatility we need to endure to get the return. If we’ve stayed for the risk, it is logical to ensure we stay for the reward.

This material is provided for information only. No account has been taken of the objectives, financial situation or needs of any particular person or entity. Accordingly, to the extent that this material may constitute general financial product advice, investors should, before acting on the advice, consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation and needs. This is not an offer or recommendation to buy or sell securities or other financial products, nor a solicitation for deposits or other business, whether directly or indirectly.

March Quarter Review

Economic Overview

There was one major theme from Q1, being the Russian invasion of Ukraine. While the human implications are the foremost concern, the outbreak of war offered a sharp reminder of how interconnected the world is today, and how quickly the implications of a military conflict feed back into financial markets. Commodity prices spiked as Russia is a major producer of oil, gas, and wheat, while Ukraine is also a large exporter of wheat, corn and one of the world’s largest exporters of seed oils. This, combined with ongoing supply chain issues, contributed further to the surge in inflation, while renewed Covid-19 outbreaks in China hampered their recovery. As data from Q4 was released, it showed one of the strongest years for growth across the world since the 1980’s, but more pressing issues quickly pushed any euphoria aside, resulting in Q1 being a poor one for many sharemarkets.

In the US, the Russian invasion of Ukraine was widely condemned and prompted a significant range of sanctions from the US and its allies. With the Russian economy heavily reliant on oil, President Biden banned Russian oil imports. Russian central bank assets were also frozen, as the US and its allies coordinated to deny Russia access to the global financial system.

The Russian invasion amplified inflation concerns, particularly in food and energy. In March US petrol prices recorded the biggest month-on-month increase since the oil price shocks in the mid-1970s. Other US economic data remained encouraging, with the Manufacturing and Services Purchasing Managers’ Indexes (PMI) both strong. US unemployment dropped from 3.8% in February to 3.6% in March, and while wages continue to rise, they are being outpaced by headline inflation. Annual US inflation, as measured by the consumer price index (CPI), hit 7.9% in February, which is a 40-year high. The Federal Reserve finally raised interest rates by 0.25% in March, with internal calls for further aggressive tightening and discussion of 0.5% increases.

GDP Growth (RBA 2022

Unfortunately, US consumer confidence continues to decline and according to the University of Michigan Consumer Sentiment survey, consumer confidence is at the lowest level since August 2011. Inflation is the primary culprit for the pessimism, with more consumers highlighting reduced living standards due to rising inflation. An NBC News poll saw 65% of respondents saying their family’s income is falling behind the cost of living.

In the Eurozone, the Russian invasion led to a spike in energy prices and caused much concern about ongoing energy supply. Germany suspended the approval of the Nord Stream 2 gas pipeline from Russia, while European Commission announced a plan to diversify sources of gas and speed up the roll-out of renewable energy. Either way, becoming overly reliant on Russia was a self-inflicted problem, particularly for Germany and long term plans don’t alleviate current issues, with genuine concerns high energy prices will dampen business and consumer demand. In response to rising inflation, the European Central Bank outlined plans to end bond purchases by the end of September, while ECB President Christine Lagarde suggested an interest rate rise was potentially on the cards. Data showed annual eurozone inflation at 7.5% in March, up from 5.9% in February. The flash eurozone composite purchasing managers’ index (PMI) slipped to 54.5 in March from 55.5 in February, however above 50 still represents expansion.

In the UK, The Bank of England increased interest rates by 0.5%, with two consecutive 0.25% hikes, this was on top of December’s 0.15% increase. The Office for Budget Responsibility expects UK CPI to hit 8.7% in Q4 2022 (previous forecasts had been to peak at 4.4% in the second quarter of 2022) before falling back in Q1 2023. While the UK is less exposed to energy imports from Russia than Europe, the wider impact on commodity prices only added to existing supply problems and the higher cost of energy. Chancellor of the Exchequer, Rishi Sunak, unveiled a £6 billion fiscal package to help combat the rising cost of living. UK economic data remained positive upbeat throughout the quarter, with both the Services and Manufacturing PMI showing healthy expansion. Wages continued to rise, as unemployment continued to fall.

Despite Japan’s proximity to Russia, the countries aren’t large trading partners. For Japan, Russia accounts for around 1% of exports and 2% of imports. The majority of imports are energy, specifically LNG, while exports are mostly auto-related, prompting auto makers to suspend links. The yen weakened against all major currencies in March and hit a six-year low against the US dollar as US interest rates increased. In the last week of March, the Bank of Japan conducted bond purchase operations for several days, this was a major signal the BOJ will attempt to keep bond yields near its current target rate of zero. Long-term supply constraints continued to impact growth in the automotive production industry.

In China, the number of Covid-19 cases (with Hong Kong) spiked to their highest level in two years. China’s financial capital of Shanghai, with a population of 25 million people, went into a partial lockdown at the end of the quarter in a bid to curb a surge in Omicron Covid-19 cases. Several other major cities saw lockdowns which led to the shutdown of multiple manufacturing factories, further disrupting the global supply chain. Issues such as the technology regulatory crackdown and the Evergrande debt default continued to linger, but these issues were mostly overshadowed by both geopolitical matters and and the re-emergence of Covid-19. Sentiment improved towards the end of the period as the National People’s Congress confirmed a 5.5% GDP growth target for the year.

The major Emerging market story was obviously Russia. Economic sanctions, including the removal of Russian banks from the SWIFT international payment system, led the Central Bank of Russia to increase interest rates to 20% to stem cash withdrawals by the public. Some of the world’s largest companies shuttered stores and committed to stop trade in Russia. The government also attempted to rescue the rouble, which had essentially collapsed. In response, the Central bank announced that all European payments for energy must be paid in the local currency, rather than euros or dollars. The emerging market beneficiaries were those with net commodity exports, such as Middle Eastern and Latin American countries.

Back in Australia, data released in March 22 showed GDP increasing by 3.4% for Q4 2021, with year-on-year growth at 4.2%. This was the strongest quarter of growth since the 1970’s Household spending was up 6.3% as Australia’s two largest states moved out of lockdown in the final quarter of 2021. Not surprisingly, the big jumps came with a 24.3% increase in spending on hotels and eating out and 17.1% increase in recreation spending, as people left the house again. Unemployment data for February 22 showed unemployment at 4.0%, the lowest in 13 years. While many other central banks were raising interest rates, the Reserve Bank seemed steadfast in its language from the March meeting, noting “the Board will not increase the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range. While inflation has picked up, it is too early to conclude that it is sustainably within the target range.”

Market Overview

The following outlines the returns across the various asset classes to 31st March 2022.

Global sharemarkets were volatile and quite poor in Q1. Bonds were a bigger story, with yields moving upward sharply during the quarter as the US Federal Reserve became more hawkish and pulled the trigger on a .25% rate rise. The 10-Year US Treasury yield moved from 1.51% to 2.35% with 2-year yields rising from 0.73% to 2.33%. In the UK, the 10-year yield jumped from 0.97% to 1.61%. The Australian 10-year yield moved from 1.67% to from 2.84%. All these upward movements in yields helped contribute a to fall in bond prices both globally and locally.

US shares were negative in Q1, with January and February pushing the market into correction territory, before a recovery rally for much of March. Looking at fundamentals, company earnings rebounded strongly in 2021, posting growth of 70% for the year. This reflected some of the most important sectors of the U.S. market, such as technology, communication services, health care, and consumer staples, saw few negative impacts from the pandemic, and even enjoyed stronger revenues. For the quarter, energy and utility companies were among the strongest performers, with technology, communication services and consumer discretionary the weakest.

Eurozone shares fell quite sharply in the quarter and among the worst global performers. The region has close economic ties with Ukraine and Russia, with a heavy reliance on Russian oil and gas. Energy was the only sector to see a positive return, with the heaviest falls coming in consumer discretionary and information technology sectors. Worries over consumer spending led to declines for stocks such as retailers. Austria, Ireland, Sweden, Finland, and Hungary, all saw double digit declines, while the larger French and German markets recorded mid single digit losses.

UK shares were more resilient than most of their global counterparts. The large cap FTSE 100 saw a 1.8% gain for Q1, but smaller areas of the market suffered. UK shares were driven higher by energy, mining, healthcare, and banking sectors. The UK market has a small allocation to technology, so it was far less affected than other markets. Strength in the banks reflected rising interest rate expectations, but consumer focused areas underperformed, and UK small and mid-cap shares were sold off heavily.

Japanese shares were weak in January and February, but rallied in March to end Q1 only slightly lower for the quarter. One of the bigger themes in Japanese shares was US interest rate expectations. The Fed Reserve minutes, and the 0.25% rate increase in the US, changed the market’s focus, with value-style companies outperforming growth. Much of the gain in value companies came from financial-related sectors such as banks and insurance

Asia (ex-Japan) and Emerging markets shares experienced sharp declines in Q1 amid a challenging market environment dominated by the Russian invasion of Ukraine. Share prices in China were sharply lower, while shares in Hong Kong, South Korea and Taiwan also fell. There were small pockets of growth such as Indonesia, which saw solid gains, while Thailand, Malaysia and the Philippines also moved upward.

As a whole, sentiment toward emerging markets was very sour due to Russia’s invasion of Ukraine. Despite a vast difference between various emerging market indexes, investors basically shunned the asset class, as it saw large outflows during late February and March. Russia itself was was removed from the MSCI Emerging Markets Index in early March, priced at effectively zero. Individually, commodity exporters such as Kuwait, Qatar, the UAE, Saudi Arabia, and South Africa saw good gains.

The Australian market (All Ords Accumulation) saw a 1.62% return, being one of the few developed markets to gain over Q1. The sector strength across the quarter came from energy (25%), materials (12%) and utilities (12%). Financials were incredibly volatile across the quarter with a 10% dip in January, a sharp recovery in February, before another almost 10% dip in early March, before recovering to finish up 3.6% for the quarter.

Some of the former market darlings in the buy now/pay later space were again smashed. Zip lost 65% for the quarter, despite launching a takeover for competitor Sezzle, in an attempt to consolidate the sector. It appears Afterpay accepting a takeover by US company Block was Afterpay’s founders and shareholders having the good sense to leave the party early. The sector long had its critics, and it seems the spectre of bad debts and interest rate rises are beginning to bite. In contrast, the ASX small ordinaries had a new hot sector in town, as some lithium explorers boomed across Q1.

This material is provided for information only. No account has been taken of the objectives, financial situation or needs of any particular person or entity. Accordingly, to the extent that this material may constitute general financial product advice, investors should, before acting on the advice, consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation and needs. This is not an offer or recommendation to buy or sell securities or other financial products, nor a solicitation for deposits or other business, whether directly or indirectly.

December Quarter Review

Economic Overview

The major themes from Q3, namely labour and supply shortages, shipping bottlenecks and inflation, all flowed into Q4, but they were joined by a new contender for investor attention: the Omicron Covid variant. Despite Omicron being more contagious, some countries resolved to push on through the wave of infections, while others reintroduced restrictions to try and reduce the spread. As data from Q3 filtered out during Q4, it showed economic growth was slowing, but 2021 sees several major economies on track to record their strongest GDP growth in more than thirty years. Finally, some central banks have stepped up to combat inflation with interest rate rises coming fast in emerging markets.

In the US, data showed economic growth slowed in the third quarter as Hurricane Ida, supply chain delays, labour shortages and Covid infections all played a role. GDP increased at 2.3%, up from an estimated 2.1%. This was the slowest quarter of growth since the historic contraction in the second quarter of 2020, as the US attempted to contain the first wave of Covid. However, economic activity was showing signs of strengthening again before a late Q4 Omicron dip. Regardless, estimates show the US economy remains on track to record its best performance since 1984, with fourth-quarter growth suggested at an annualised rate of around 7%.

Unemployment fell to 4.2% in November, the lowest figure since February 2020, down from 4.6% in October. The participation rate rose slightly, but was still about 1.5% lower than the pre-pandemic level. Inflation became a bigger topic during the quarter as annual inflation jumped to 6.2% in October and then 6.8% in November.

During the quarter the Federal Reserve admitted inflation has been both higher and more persistent than anticipated, with inflation significantly surpassing the Federal Reserve Open Market Committee’s 2% target. Chairman Jerome Powell also said it was time to retire the “transitory” word we’ve been accustomed to hearing, suggesting the word has different meanings to different people. While we may have thought it meant “a sense of short-lived” the Fed meaning is “it won’t leave a permanent mark of higher inflation”. If that’s not clear, we can at least be grateful we’re unlikely to hear the term “transitory inflation” again!

In the Eurozone, the Omicron variant was the dominant version in many European countries by the end of Q4. Germany, Portugal, and the Netherlands were among several countries to reintroduce restrictions on sectors such as travel and hospitality, as they tried to reduce the spread of the Omicron variant. This was on the back of a warning from the World Health Organization that a surge in cases across Europe would push health systems towards the brink of collapse. As a result, the flash PMI hit a nine-month low of 53.4 for December, as the Euro service sector was hit by rising Covid cases. Meanwhile, fuel prices were volatile and contributed to higher inflation with the Eurozone’s annual inflation rate hitting 4.9% in November, compared to -0.3% a year earlier. The European Central Bank said it would begin to scale back bond purchases, but ruled out increasing interest rates in 2022

In the UK, a big story was the surprise move from the Bank of England (BOE) to raise interest rates by 15 basis points to 0.25% in December. The rate had been at 0.10% since March 2020. The move was a surprise firstly because of Omicron, but also because despite voicing concerns in Q3 that inflationary pressures were surpassing expectations, likely to peak above 4% and remain high in 2022, the BOE underlined that it wouldn’t act in the short term. CPI inflation hit 4.2% in October and 5.1% in November, which may have helped cement the decision. The bank noted, “there was some value in waiting for further information on the degree to which Omicron was likely to escape the protection of current vaccines and on the initial economic effects of this new wave,” but “there was, however, also a strong case for tightening monetary policy now”. Q3 GDP came in at 1.1% growth, with estimates of 2021 UK GDP growing by around 6.8%.

In Japan, a general election was held in October and there were modest expectations for the ruling Liberal Democratic Party. However, the LDP lost only 15 seats and retained a decent majority in its own right. The political focus then shifted to a substantial fiscal stimulus package. The package came with direct cash handouts to households as the government attempted to kick-start a recovery after a 0.9% decline in quarterly GDP in Q3. Like elsewhere, there was short-term uncertainty as Japan had its first case of Omicron in December, but as with the prior variants, infection rates continue to remain surprisingly low by international standards. Another surprise was the strength of the rebound in industrial production which increased 7.2% October to November, fueled by a 43% resurgence in car production.

In China, factors such as the property-market downturn, triggered by the collapse of developers, flooding and power rationing, have all been drags on economic growth. Figures for Q3 showed GDP grew 4.9% annually, down from 7.9% in Q2. While some forecasts have China’s 2021 GDP figure coming in around 8%, growth is expected to slow to less than 5% in 2022. Energy usage is expected to play a larger role in dictating Chinese GDP in 2022. Pollution controls will be enacted ahead of the Winter Olympics and Paralympics across February and March, while China’s dual-control system, which aims to reduce 2020 levels of energy consumption and GDP carbon intensity by 13.5% and 18% over the next few years. This will likely lead to further power rationing.

Emerging market countries saw currency volatility and inflation continue to spike across the quarter. EM Central Banks had differing responses to their problems. The Turkish lira was extremely volatile as the central bank lowered its rate by a total of 4% to 14%, despite inflation hitting to 21.3% annually in November. With the lira under pressure, President Erdogan announced lira holders would be compensated for currency losses. In Brazil, the central bank increased rates another 3% over the quarter to counter inflation. Interest rates also increased in Mexico, Hungary, Chile, Russia, and Poland during the quarter.

Back in Australia, data released in November showed GDP fell by 1.9% for Q3, with year-on-year growth at 3.9%. The quarterly contraction was expected, due to lockdowns in NSW and Victoria, where there were falls in household consumption and services affected by the lockdowns. Government support again played a role in cushioning household and business balance sheets, with data showing the household saving rate jumping from 11.8% to 19.8% in Q3, suggesting potential for a robust recovery at some point. Late November/early December data signaled a solid rebound was already underway, but self-imposed restrictions and close contact isolations in mid to late December appeared to put a dampener on the recovery as Omicron cases spread.

Australians continued to bid up property prices, with data from the Australian Bureau of Statistics showing the fastest rise of property prices since it first started tracking them in 2003. Combined capital city prices saw three consecutive 5%+ quarterly increases, something that hadn’t occurred in the time the ABS has kept data. Pre pandemic, Sydney house prices had attempted to move back toward wages. However, over the past year, Sydney house prices have now completely divested themselves from wages.

Data for Q3 showed 23.8% of new home loans had a debt-to-income ratio of six or higher, a threshold considered risky by the Australian Prudential Regulation Authority. A year earlier that figure stood at 16.3%. For its part, the RBA statement from December seemed unperturbed by house prices, highlighting “inflation pressures are also less than they are in many other countries” and despite market commentary around rate rises, reiterated “the Board will not increase the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range”.

Market Overview

Asset Class Returns

The following outlines the returns across the various asset classes to 31st December 2021.

In Australian dollar terms global sharemarkets were very strong in Q4, overcoming some brief volatility prompted by the emergence of Omicron in the second half of the quarter. Yields rose slightly in longer dated bonds in the US. After hitting 1.7% in October and falling to 1.36% in early December, the 10-Year US Treasury yield settled at 1.51%. In the UK, the 10-year yield moved slightly downward from 1.02% to 0.97%. The Australian 10-year yield spent much of the quarter edging higher, eventually finishing at 1.67%, up from 1.48% at the end of Q3.

US shares rose in Q4. Overall gains were strong despite the weaker November, where rising Covid cases and the speed of the Federal Reserve’s asset tapering hit markets. By the end of December worries had subsided and data was indicating the economy remained stable and corporate earnings robust. This marked the third consecutive year of double-digit gains in the US with 70 new highs made by the S&P 500 during 2021. Tech was a strong performer over the quarter, with chipmakers especially strong. Real estate also shone as investors expect e-commerce to grow and drive increasing demand for industrial warehousing. Energy and financials names made gains, but were more subdued.

Eurozone shares gained over the quarter the focus turned to strong corporate profits and economic resilience, this alleviated worries about Omicron. Like in the US, markets across the Euro also drew support from data suggesting Omicron presented a lower risk of severe illness. Utilities were among the bigger winners, with IT companies notching strong gains. Technology hardware and semiconductor stocks performed particularly well while the luxury goods sector recovered from a sell off over the northern summer sparked by the “common prosperity” shift in Chinese policy. Meanwhile, the communication services and real estate sectors saw negative returns.

UK shares posted gains with the most economically sensitive areas such as banks recouping the losses seen in late November when Omicron emerged. It was a different story for sectors reliant on the economy reopening, such as travel and leisure, along with the energy sector. All were unable to make up November’s losses, posting losses for the quarter. Retailers and housebuilders gyrated with expectations of an interest rates movement, while retailers continued to struggle with supply chain disruptions. Despite the high demand, the disruptions resulted in the highest number of profit warnings in listed retailers since 2017.

Japanese shares seesawed with falls in October due to election uncertainty, but when the ruling LDP limited their election losses to a smaller number of seats than expected, a rally followed. November saw shares hit a five-month low, as news of Omicron emerged, punishing travel and tourism companies. By December, the bargain hunters emerged, and Japanese shares regained some ground as tech companies reported strong results. SoftBank was a big loser for the quarter, as its portfolio comprising large holdings in Chinese companies, such as Alibaba and Didi, ran into various Chinese regulatory hurdles.

Asia (ex-Japan) and Emerging markets were both negative in Q4, with the stronger US dollar acting as a headwind. Turkey, with its currency woes was the weakest index. China and Hong Kong were also poor performers, as there were concerns lockdown restrictions would accompany the rapid spread of Omicron. India and South Korea also ended the quarter in the red, but the declines in share prices were more modest. Chile lagged on the election of leftist Gabriel Boric as president.

Taiwan and Indonesia were strong performers, and the only two Asian markets to surpass a 5% gain for Q4. In Taiwan, a rise in exports boosted investor confidence, with chipmakers and IT companies performing well. The Philippines, Mexico and Malaysia also ended the quarter in positive territory. Peru, the UAE, and Egypt all posted double digit gains.

The Australian market (All Ords Accumulation) almost notched 2.5% return for the quarter to deliver almost 18% for the year. Q4 strength was found in real estate (REITs delivered a double-digit return), communication, utilities, and materials, which bounced after a large sell off in Q3. Most other sectors were either slightly up or slightly down for the quarter without much decisive movement either way. The real punishment for the quarter came in the buy now/pay later space. Afterpay, which was hitched to US company Block, due to a script takeover, fell over 30% during the quarter. Many of Afterpay’s smaller imitators saw similar results as the prospect of more regulation in the space loomed.

This material is provided for information only. No account has been taken of the objectives, financial situation or needs of any particular person or entity. Accordingly, to the extent that this material may constitute general financial product advice, investors should, before acting on the advice, consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation and needs. This is not an offer or recommendation to buy or sell securities or other financial products, nor a solicitation for deposits or other business, whether directly or indirectly.

September Quarter Review

Economic Overview

Labour and supply shortages, shipping bottlenecks, COVID delta variant, inflation, vaccine hesitancy. There were plenty of worries in Q3, but markets remained mostly positive across the quarter as economies continued to open and society resumed some normality. This led to an increase in demand in many areas and a struggle to supply that demand. Something governments, businesses and central banks will be dealing with in the year ahead.

In the US, the Fed Reserve stated tapering of quantitative easing will be announced at the November meeting and will finish by mid-2022. Interest rate expectations also moved higher. The 2023 interest rate expectation moved from two increases to three, with another three increases expected in 2024. While 2021 real GDP growth was revised down to 5.9% from 7% growth previously estimated, GDP projections for 2022 and 2023 were increased. Notably, inflation has risen with the Fed now seeing inflation running at 4.2% across 2021, above its previous estimate of 3.4%. Inflation did slow in July and August at 5.35% and 5.25% on the year, but edged up in September to 5.39% annually. These figures are around 13-year highs.

COVID continues to hamper the supply chain, the third largest container port in China was shut for several weeks in August due to one positive COVID case. The backlog stretched across the Pacific to the Los Angeles and Long Beach ports, which together handle about a third of all containers arriving in the US. Such disruptions reverberate along the supply chain, then in the US there was an added problem of a shortage of long-haul truck drivers.

The shortage of labour became a bigger issue in Q3. There has been confusion as to why US businesses are having trouble hiring and hanging onto workers. In something that has been termed “the great resignation” there could be several factors. The desire for flexibility is one reason. According to the job site Glassdoor, searches for remote work are up 460% in the two years through June 2021. Clearly jobs in restaurants, hotels, and retail can’t be done remotely, but recent articles in publications such as the Wall Street Journal, The New York Times and The Atlantic highlighted changing attitudes to work. Many workers used the pause the pandemic offered, via stimulus payments and free time, to either retrain or look for different work. Some service industry employees returned after lockdown to find the American consumer increasingly rude and verbally abusive, so they tossed in their job. Others simply retired.  As the Fed recently highlighted, there is a financial cushion. The net worth of U.S.households was $142 trillion in Q2 2021, up from $110 trillion pre COVID. Beyond investments, there was $17 trillion in cash and cash equivalents on household balance sheets as of June 2021.

In the Eurozone, the Delta variant of COVID continued to spread, but vaccinations rates in the larger eurozone countries now sits around 75% which has seen restrictions on travel and other activities lifted. As the quarter progressed, inflation, due to supply chain issues became a concern. Eurozone annual inflation was estimated at 3.4% in September, up from 3.0% in August. The European Central Bank suggested “inflation is currently being pushed up largely by temporary factors that are expected to fade in the coming years”, announcing a reduction in the pace of asset purchasing, noting it would tolerate a moderate and transitory overshoot of the 2.0% inflation target. The end of the quarter saw a surge in power prices due to low gas supply and weather-related issues over the summer. Germany held a general election, with the Social Democrats (SPD) receiving largest share of the votes. Coalition talks are under way to form a new government.

In the UK, inflation hit 3.2% annually in August, up from 2% in July and the Bank of England took a hawkish tone, voicing concerns publicly that inflationary pressures were surpassing expectations and likely to peak above 4% and remain high until 2022. At the same time, it reiterated its position that it won’t take action for the time being. Like the US and EU, supply bottlenecks constrained output, while natural gas and fuel shortages cropped up towards the quarter’s end. The vaccination programme continued to reduce the number of virus-related hospitalisations despite the emergence of the delta variant. As a result, the UK government moved to the final easing of lockdown restrictions in July.  Payroll figures moved above pre-pandemic levels and furloughed workers continued to decline across the UK. GDP figures showed the UK economy grew by 4.8% in Q2.

In Japan, politics dominated as Prime Minister Suga stepped down as leader of the Liberal Democratic Party (LDP). Fumio Kishida took over as party leader and Japanese PM. He will lead the LDP into November’s general election. While Suga faced widespread criticism over his handling of the pandemic and his popularity was fading, the announcement was still a shock given he’d only spent 12 months in the role. PM Kishida has flagged additional fiscal stimulus to support the economy through the pandemic.

China’s woes began to unnerve investors in the quarter as the government looked to assert more control in the technology and property space. In technology, China has dished out large fines for monopolistic practices, Alibaba was hit with a record $3.8 billion AUD fine. In property, authorities are looking to rein in debt and bring prices under control, with Evergrande Group struggling to clear $300 billion of debt potentially being a casualty. Evergrande sparked global investor concerns as a default for the group would not only be disastrous for China’s real estate sector (28% of GDP) but would have a significant domino effect throughout the economy, and potentially globally. China is also facing a power shortage, impacting factories and homes, while also trimming economic growth forecasts.

Emerging market countries saw winners and losers due to power and supply chain issues; this was particularly notable across Asia. In South America, Brazil saw several months of interest rate increases to tackle excessive inflation, flagging another to come in October, while metal prices capped growth for other South American nations such as Chile and Peru. Those with significant energy resources such as Russia and several Middle Eastern economies did well. India continued to make progress against the spread of COVID and by the end of the quarter had administered nearly one billion doses, second only to China.

Back in Australia, data released in September showed the economy grew 0.7% for Q2, with year-on-year growth 9.6%, but showed growth slowing from Q1 before the COVID outbreaks in NSW and Victoria. The continued presence of COVID in the two largest states led to more vaccination urgency. By the end of the quarter, 77.8% of Australians over 16 had been administered their first dose and 54.2% of Australians over 16 were fully vaccinated.

Towards the end of the quarter there were media rumblings there would be an intervention in the mortgage market by the Australian Prudential Regulation Authority. There were suggestions of a limit on borrowing, as various housing markets had increased over 25% annually, fuelled by low interest rates. This followed the OECD and International Monetary Fund both calling on Australian regulators to step in to cool the Sydney and Melbourne property markets.

In its September minutes the RBA again said it “will not increase the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range”. Inflation increased to 3.8% in Q2 2021 with the largest increases coming in fuel, pricing for furniture due to timber prices and supply shortages and childcare as free childcare was ended.

Global economic growth is expected to be 6% for 2021 and 4.9% for 2022, according to the International Monetary Fund. If realized, this would be the fastest growth in several generations as 1973 was the last time growth was 6% or higher.

Market Overview

Asset Class Returns

The following outlines the returns across the various asset classes to 30th September 2021.

Global sharemarkets in Australian dollar terms were reasonably strong in Q3, albeit with some headwinds emerging in September, which is historically the worst performing month for equities. Yields rose in longer dated bonds in the US and UK, the 10-Year US Treasury yield edged higher from 1.47% to 1.50%, while the UK 10-year yield moved sharply upwards from 0.72% to 1.02%. Despite falling early in Q3, the Australian 10-year yield pushed upwards sharply with the release of Q2 inflation data to finish flat at 1.488%.

In the US, shares notched a positive return in Q3 with the S&P 500 up 0.58%. Strong earnings had lifted US shares in the run up to August, when the Fed Reserve struck a dovish tone, confirming its hesitance to tighten policy too fast. However, a double whammy of growth and inflation concerns late in the quarter saw US shares pull back in September and deliver their worst month since March 2020. Across the sectors, financials and utilities outperformed while industrials and materials struggled, although the September sell-off hit almost every sector. The exception was energy, as supply constraints drove natural gas and oil prices to highs.

Eurozone shares were mostly flat in Q3. The energy sector was one of the strongest performers, along with information technology with semiconductor-related companies due to the shortage in that space. Consumer discretionary companies struggled, with luxury goods area specifically under pressure with talk China could seek greater wealth redistribution, which could hit demand. Like elsewhere the quarter started positively, due to a series strong corporate results, but pulled back as through the quarter.

UK shares rose made gains in Q3, driven by a variety of factors. The clear sector winner was energy due to rising crude oil prices. Consumer discretionary companies struggled while consumer staples were strong. Merger & acquisition was again a theme. Wm Morrison Supermarkets takeover bid was recommended, US sports betting group DraftKings made a bid to acquire Entain, and US parts manufacturer Parker Hannifin made a bid for UK aerospace and defence equipment supplier Meggit. It was strong quarter for UK shares, outperforming all other major developed markets, with the exception of Japan.

In contrast to much of the world, Japanese shares were rangebound through July and August before rising in September to record a total return of 5.2% for Q3. While corporate results for the previous quarter were strong, sentiment was impacted in August as Toyota announced production cuts in September and October, due to the global shortage of semiconductors.

The rest of Asia and Emerging markets were negative in Q3. This was driven by the significant sell off in China, but also continued supply chain disruptions, worries over the implications of higher food and energy prices weighed on many emerging market countries. Brazil was the weakest market overall, as inflation took hold and its central bank responded with rapid fire rate rises. By contrast, the energy exporters generally outperformed, most notably Colombia, Russia, Kuwait, Saudi Arabia, Qatar and the UAE.

The Australian market (All Ords Accumulation) backed up its strong Q2 with another positive quarter. Transportation, consumer services, insurance and energy were the strongest performers. The strength in transportation can be attributed to the interest of superannuation and global pension funds in infrastructure assets such as airports. Sydney and Auckland airport shares were up sharply for the quarter, along with Qantas. The worst performer was the second largest sector, materials. The iron ore sell off hit BHP, Rio Tinto and Fortescue hard, the trio also went ex-dividend with big payments, but the juicy dividends couldn’t offset the price falls.

This material is provided for information only. No account has been taken of the objectives, financial situation or needs of any particular person or entity. Accordingly, to the extent that this material may constitute general financial product advice, investors should, before acting on the advice, consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation and needs. This is not an offer or recommendation to buy or sell securities or other financial products, nor a solicitation for deposits or other business, whether directly or indirectly.

June Quarter Review

Economic Overview

Attention turned to vaccinations and reopening economies in the second quarter of 2021, by the end of the quarter over 3 billion vaccine doses had been administered globally. There are now strong indicators of a robust and lengthy economic expansion ahead. Around the world there are now businesses desperate to hire new employees, millions of consumers with money burning holes in their pockets, and ongoing fiscal and monetary support from governments and central banks.

In the US, the positive news around COVID was vaccinations. While President Biden had set a goal of 70% of all adults vaccinated by July 4, analysis by The New York Times in late June suggested the US would fall short, with around 67% of adults partially vaccinated. The Centers for Disease Control and Prevention (CDC) figures showed 45% of Americans had been fully vaccinated near the end of Q2. The laggards were those aged between 18 and 26. The negative news was the Delta strain of the virus. Delta is more contagious and according to the CDC was accounting for over 20% of US cases at the end of June.

The increasing vaccination rate is contributing to the resumption of travel and dining out across the US. Various data points have shown restaurant traffic back to, and even above, pre-pandemic levels. Air traffic remains 24% down and hotel occupancy down 10%, but significant progress has been made across the quarter. Since March, the US economy added 1,702,000 jobs and net growth in payrolls since last May 2020 totals 15.6 million. In late June, President Biden also secured a deal on a $1 trillion infrastructure package to upgrade roads, bridges and communications networks.

Late in the quarter there was some panic around potential responses to inflation as the Federal Reserve’s Open Market Committee unveiled unexpected rate hike projections for 2023. These were accompanied by increased inflation and economic projections for 2021. However, Fed Chair Jerome Powell attempted to dampen the hawkish forecasts by noting much progress is still needed and future changes to the asset purchase program will be “orderly, methodical and transparent.”

In the Eurozone, the pace of vaccine roll-out accelerated as many countries saw COVID cases fall through the quarter. Falling cases combined with increasing vaccination rates saw social and economic restrictions loosen. Economic data was positive and pointed to a strong rebound in Q2. The flash Markit eurozone composite PMI rose to 59.2 in June, this was its highest level since 2006. Eurozone inflation was estimated at 1.9% in June, down from 2.0% in May. The European Commission signed off on the first of the national recovery plans which will receive funding from the €800 billion Next Generation EU fund. This forms part of the largest stimulus package ever in Europe, a total of €2.018 trillion. The first countries to have their spending plans approved under the Next Generation fund were Spain and Portugal.

In the UK, the vaccine rollout stood at 65% of the population with at least one dose by the end of Q2. The Delta strain of the virus saw the UK government postpone the final easing of lockdown restrictions until 19th July. Economic data continued to highlight a robust recovery. Retail sales rose by 10% in May compared to the pre pandemic measure of May 2019. The Bank of England (BoE) increased its GDP growth forecast for 2021 to 7.25% from the 5.00% it predicted in February. The Bank of England left monetary policy unchanged in June and sought to calm fears over rising inflation. The Bank acknowledged that inflation would rise but suggested the surge in prices was transitory and should not affect monetary policy.

In Japan, vaccination rates increased in May getting past some of the hurdles seen in the previous quarter, but were still slow. Though infections were lower than in many other countries, cases continued to grow, leading the Suga government to delay lifting the state of emergency until June 20. Industrial production was weaker than expected, the primary reason being a slowdown in auto production caused by the global shortage of semiconductors.

China saw factory activity fall in June as raw material costs and the semiconductor shortage began to bite. While year on year GDP growth was 18.3% in Q1, this was expected to fall back into single digits in Q2 as most of China’s recovery has already occurred. Chinese manufacturing PMI slipped to 50.9 in June versus 51.0 in May. Consumer spending has been sluggish, with figures showing household expenditure lagging disposable income as Chinese consumers continue to save.

Emerging market countries saw a particularly severe third wave of covid infections. Vaccinations generally lagged developed markets as emerging market countries struggled to procure developed country vaccines. Despite spike in virus cases, the Brazilian economy rode the booming global demand for iron ore and copper, along with agricultural commodities. The Russian economy benefited from agricultural demand despite ongoing political frictions with western countries. Higher oil prices were also supportive in Russia, along with Saudi Arabia.

Back in Australia, data released in June showed the economy grew 1.8% for Q1, with year-on-year growth at 1.1%. The household saving rate also increased to 12.2% showing some caution from consumers, but also a capacity to spend. Q2 also coincided with the end of the JobKeeper program, with the economy seemingly having no problem digesting the withdrawal of support. The unemployment rate fell to 5.1% in May. On the virus front, Australia was somewhat of a victim of its own previous success when it came to getting the population vaccinated. The reports of blood clotting from AstraZeneca recipients in Q1 led to public hesitancy and changing advice around the vaccine. Notably, there was no countrywide vaccination awareness campaign from the Federal Government, while PM Scott Morrison suggested getting vaccinated “was not a race”, indicating the government may have been at ease with a longer-term border closure.

In its June minutes, the Reserve Bank noted it would “maintain highly supportive monetary conditions until its goals for employment and inflation were achieved.” And it “would not increase the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range” something the board highlighted would require significant wages growth to occur.

Market Overview

Asset Class Returns

The following outlines the returns across the various asset classes to 30th June 2021.

Global sharemarkets delivered strong returns in Q2, while yields fell in longer dated bonds in the US and UK, reversing some of the sharp upward moves of Q1. The 10-Year US Treasury yield declined from 1.74% to 1.47%, while the UK 10-year yield fell from 0.88% to 0.72%.

In the US, the S&P 500 and NASDAQ reached a new all-time high in late June, with nearly all sectors notching gains over the quarter. The tech titans such as Apple, Alphabet (Google) and Microsoft made strong gains over the quarter. Notably, Facebook joined Apple, Microsoft, Amazon, and Alphabet (Google) in the exclusive $1 trillion market-cap club. By sector, energy, IT, communication services and real estate were amongst the strongest areas of the market. Utilities and consumer staples were the laggards.

Eurozone shares advanced in the quarter, supported by a strong corporate earnings season and an acceleration in the pace of vaccine roll-out in the region. The top performing sectors were defensives, areas such as consumer staples and real estate, which had lagged in Q1 as investors focused on more economically sensitive areas of the market. Information technology was also strong, while utilities and energy were laggards. As noted, earnings for Q1 were robust across the board, with healthcare the exception.

UK shares were largely driven by lower valued and economically sensitive sectors during April and May and as sentiment improved, global investment managers reported being “overweight” the UK for the first time since 2014. However, June was a different story amid a rise in Covid-19 infections and falling inflation expectations. Defensive large cap companies were resilient in June, particularly healthcare and consumer staples. Energy also performed well in June, while financials were poor.

The Japanese market fell during Q2 despite a decent corporate results season where the majority of companies reported inline, or slightly ahead of expectations. The number of companies reporting profits below expectations has been significantly lower than normal.

The rest of Asia was mostly positive in the Q2 as investors were optimistic about economic normality. However, returns were tempered towards the end of the quarter due to a resurgence of Covid-19 infections and lockdowns due to the Delta strain. The stronger US dollar also weighed on June returns. The Philippines was the strongest index market in the quarter, while Taiwan and India also achieved positive gains during the quarter. By contrast, Pakistan, Indonesia, and Thailand all struggled as rising Covid-19 infections weighed on their respective markets.

The Australian market (All Ords Accumulation) notched a 8.66% return for the quarter. Sector strength was similar to the previous quarter, coming from financials and consumer discretionary, although most sectors posted gains. Over the financial year, consumer discretionary led the way with 42% return, followed by financials at 39% and financials 35%. Utilities continued their poor run in Q2 and were the poorest performing sector in the year to June 30, down 23%.

The Easy Money…

One of the ongoing challenges of investing is to set aside the distractions of the “here and now” to focus on the long term where true wealth is usually made. Not only do investors have to digest real events that seem concerning in the moment, but they also need to block out the commentary from market watchers that can shape opinions about what the future holds.

One of the regular lines trotted out in the financial media is how “the easy money has been made”. We’ve plotted several of these calls on a chart that tracks the growth of $1 invested in global stocks over the past 12 years. For some more context, we’ve added in a few concerning historic events in red. $1 in January 2010 turned into $5.22 at the end of June 2021. This, despite calls “the easy money had been made” 13 times.

While there’s no easy money in financial markets, the easiest money is often made by looking beyond concerns about the present, ignoring narratives about the future, and doing nothing.

This material is provided for information only. No account has been taken of the objectives, financial situation or needs of any particular person or entity. Accordingly, to the extent that this material may constitute general financial product advice, investors should, before acting on the advice, consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation and needs. This is not an offer or recommendation to buy or sell securities or other financial products, nor a solicitation for deposits or other business, whether directly or indirectly.

Swift Business Solutions is an Authorised Representative No. 1008855 and Credit Representative No. 477158 of FYG Planners Pty Ltd, AFSL/ACL No. 224543. ABN  29 009 541 253 This information is general in nature and readers should seek professional advice specific to their circumstances.

September Quarter Review

Economic Overview

As to be expected, the ongoing and dominant economic and market theme remains COVID-19. More so than ever, with COVID present no quarter will be quite like the previous. While Q1 was one of steep decline and pain, Q2 was sharp recovery and euphoria, while in Q3 markets took a slightly more subdued, albeit positive direction. Accommodating monetary and fiscal policy kept markets happy.

In the US, the economy continued something of a recovery. The Federal Reserve noted it will use average inflation targeting in setting the interest rate, allowing for overshoots in inflation. This means the Fed will allow inflation to move above 2% before it responds. The Fed’s projection path of interest rates indicates it will likely hold rates around 0-0.25% into 2023. The US unemployment rate dropped to 8.4% in August, down from 10.2% in July, while labour force participation also improved. Industrial production rose for the fourth consecutive month in August, but at a much lower rate than earlier in the summer.  Similarly, retail sales increased in August, but again at a slower rate and below expectations.

In the EU, a €750 billion fund was approved to help member states recover from the pandemic. It comprises €390 billion of grants and €360 billion of loans to be distributed among member states. Unfortunately, Covid-19 infections rose rapidly in several countries throughout the quarter, particularly in Spain and France. In response, restrictions to contain the virus were announced. Although these restrictions were localised, opposed to the countrywide restrictions witnessed in the first phase. Various European countries, including Germany, extended furlough schemes designed to support jobs through the crisis. Business activity stalled in September with the flash purchasing manager’s index (PMI) falling to 50.1, down from 51.9 in August. 50 is the level that separates expansion in business activity from contraction.

In the UK, Brexit reared its head again with the potential for a disorderly exit beginning to flare. Not far behind were concerns for a second wave of COVID-19 infections, this saw the localised restrictions imposed in the North, similar to those imposed in some of Europe.

In Japan, the dominant news story was the resignation of Prime Minister Shinzo Abe due to a long-standing health issue. Abe claimed the record as the longest continuous Japanese Prime Minister, then resigned four days later, on August 28. Yoshihide Suga, the Chief Cabinet Secretary, quickly emerged as the frontrunner, being confirmed as PM on September 16. Data for the second quarter showed Japan’s economy recorded a decline for the third consecutive quarter, with the Q2 decline of 7.9% being the largest in GDP data going back to 1955.

In China, economic data signalled ongoing recovery and Q2 corporate earnings results were positive. Q2 GDP growth rebounded to 3.2% year-on-year, after a fall of -6.8% in Q1, and was stronger than expected. However, tensions with the US escalated, including new restrictions on Chinese telecoms company Huawei, and as President Trump signed an executive order to prevent US companies from doing business with TikTok and WeChat. In India, good monsoon rains were supportive, while towards the end of the quarter the government passed agricultural and labour reforms. This was despite further increase in the number of daily new cases of Covid-19, and as tensions with China on the Himalayan border persisted

In Thailand, the lack of improvement in the tourism sector was a drag on the economic recovery. In Indonesia, Covid-19 cases rose and had an increasing impact, especially in rural areas. As a result, tighter restrictions were brought in for Jakarta.

Back in Australia, the fallout from COVID-19 became evident in headline economic data from Q2. A 7% decline in the three months to June following on from a 0.3% decline in the March quarter, confirming Australia’s first recession since the 1990’s. It was also the largest fall in quarterly GDP since records began in 1959. With borders still essentially shut to most overseas visitors for the foreseeable future the government was looking at ways to revive the economy.

One of the more interesting announcements was the Australian government flagging the removal of responsible lending laws, something many commentators flagged was a strange pursuit, given the country has the second highest household debt in the world. When it came to monetary policy, the RBA left the cash rate at 0.25%, noting in the September release that it expects inflation “between 1 & 1.5% over the next couple of years” and it will not increase the cash rate until progress is made towards full employment and  inflation is sustainably between the 2–3%.

Market Overview

Asset Class Returns

The following outlines the returns across the various asset classes to the 30th September 2020.

Global stocks gained in Q3 but regional performances diverged with Asia and the US outperforming Europe and the UK. Government bond yields were little changed, however, corporate bonds enjoyed a positive quarter. As we noted last quarter government and central bank stimulus are playing their part, while ultra-low rates on cash and bonds means some investors are forced to take additional risk, which may be more supportive of higher stockmarket valuations.

US stocks gained in Q3, but struggled across September amid a resurgence of Covid-19 cases and political fighting over refreshed fiscal stimulus measures. Worries also grew over language used regarding a smooth transition of power if President Trump loses his re-election bid. Consumer discretionary areas, such as restaurants and appliances or apparel retailers performed well. Distribution companies were stronger and helped lift the industrials sector, while several airlines still facing headwinds from languishing passenger numbers, offered slightly positive returns. Energy companies remained weak on poor expectations for fuel demand.

Eurozone stocks were basically flat over the quarter. Economic data slowed over the quarter and worries took hold over sharply rising Covid-19 infections in many European countries. The energy and financial sectors saw the largest falls while materials and consumer discretionary advanced, automotive companies also generally fared well.

UK stocks lagged behind other regions during the quarter. This extending their year-to-date underperformance due to the market’s significant exposure to stocks in the oil and financial sectors. Performance was further undermined when UK focused areas of the market were hit in September with the re-imposition of localised restrictions and fears about the impact of these on the UK economy. Pound strength against a weak US dollar weighed on large UK companies with exposure to international markets.

Japanese stocks performed strongly with the Topix Index recording a 5.2% total return. This was despite a gradual strengthening of the yen against the US dollar over the period. Although corporate profits are still under pressure, the earnings season which concluded in early August, brought more positive surprises than many expected.

Asia ex Japan stocks recorded a strong return in Q3, led by Taiwan, where IT sector stocks underpinned gains. India, South Korea and China all posted double-digit returns and outperformed the MSCI Asia ex Japan index. Emerging market equities registered a robust return in Q3, aided by optimism towards progress on a Covid-19 vaccine and ongoing economic recovery. US dollar weakness proved supportive. The MSCI Emerging Markets Index increased in value and outperformed the MSCI World.

In Australia, the ASX managed a positive total return, despite some of the largest companies such as the big banks, BHP and CSL finishing slightly lower. Darlings such as Domino’s and buy now pay later company Afterpay continued to power on. The strongest performing sectors were consumer discretionary and information technology. This seemingly still reflects stimulus and early superannuation release sloshing around the economy, while IT is still benefiting from technological changes as workplaces adapt to various COVID related changes. Energy slumped further, as it did elsewhere across the globe.

From an Australian perspective looking globally, unhedged international stocks again trailed their hedged counterparts as the Australian dollar strengthened with the recovery. International small caps trailed their larger counterparts over the quarter, something that has become a theme for much of the last decade. A similar theme has emerged in the laggard value space. When will these risk premiums return to favour? Unsure, but they can never be ignored. That’s why they’re called risk premiums because they’re not always present. There’s always the next quarter.

Additional material sourced from Schroders.

This material is provided for information only. No account has been taken of the objectives, financial situation or needs of any particular person or entity. Accordingly, to the extent that this material may constitute general financial product advice, investors should, before acting on the advice, consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation and needs. This is not an offer or recommendation to buy or sell securities or other financial products, nor a solicitation for deposits or other business, whether directly or indirectly.

So we are in a Recession.... What does that mean for stock markets

Please click through to this great visual produced by Dimensional Fund Advisers. It shows information on market returns through the many recessions that we have experienced in the last 100 years. It demonstrates the forward-looking nature of markets and how developing an investment strategy that suits your personal objectives, and sticking to it through market volatility can not only produce better returns, but hugely improve your investment experience and your relationship with the stock market.

Dimensional - Market Returns Through a Century of Recessions

Gold is up!

Should I buy Gold as an investment?

Every now and then I get asked about gold as an investment. My view is that it is a speculative investment whose price is often driven up by fear and down by strong markets. You will have noticed some fear around recently I’m sure, and this has driven up the gold price to its current level of US$1,700 per ounce.

You may also be aware that the Australian dollar is currently very weak against the US dollar. So, if you are an investor in Australia and you hold gold, you have the added benefit of the currency rate further boosting your increase in investment value.So, if you bought gold in Australian dollars about a year ago you’d be pretty happy right now.

However, long term wealth creation requires your investments to perform well for decades at a time. When we build portfolios we adhere to a firm set of beliefs about long term market characteristics of a range of asset classes. Each asset class contributes something to the portfolio. Normally ‘growth’ or ‘stability’. We accept that risk and return are inextricably tied, so we balance the requirements of the client to build a portfolio that will perform at the highest level possible having regard to the volatility the client situation can withstand. Where possible, we take only the risk required to achieve the goal. Most of the assets we invest in also produce income in the form of dividends, rent or coupon payments. These inflows can be an income source for the client or be reinvested to compound our gains in the long run.

So, what is Gold’s role in all this? Is it a good growth asset?

Whilst, like any share or property, gold has periods where it’s performance well and truly beats the broader market, in the long run gold has performed poorly compared to other growth assets.

A long run chart below shows gold v global shares (growth assets) and Treasury Notes (defensive assets) over a 40-year period. As you can see, gold has not performed well compared to other growth assets.

So, perhaps gold is a defensive asset?

The only purpose for defensive assets is stability and liquidity. But gold has proven to be significantly more volatile than defensive assets such as Treasury Notes over a 30-year period with only a slight improvement in performance. It just doesn’t do what we need defensive assets to do. Couple the fluctuations in price with fluctuations in exchange rate and gold is much too volatile to hold as a defensive asset in the long run.

The graph below shows gold values in US and AUS dollars. As you can see, the exchange rate has a significant effect on the increases and decreases in value over time.

There’s another thing about gold. It doesn’t really do anything. It doesn’t produce anything, it doesn’t feed anyone, or cure anyone, it doesn’t pay an income in the form of a dividend or rent. Just under 80% of gold mined gets turned into jewellery. There is no question that is a growth area, with the significant majority heading to India and China. Nearly 20% ends up as bullion and only about 3% of gold goes into any form of technology, engineering or medicine etc. The only way gold as an investment will ever work for you is to buy it (at the right time), wait for it to go up and then sell it (at the right time), pay your transaction costs, pay your capital gains tax and then start looking for the next investment idea.

Summary

If you like the idea of owning a small amount of gold for a certain period of time as a speculative endeavour that’s great. If you got in three years ago and got out last week then you’ve done really well. But as a large component of a long-term investment portfolio we believe there are other, less speculative assets that will serve you better in the long run.

March Quarter Review

Economic Overview

The spread of COVID-19 had a significant impact on global economies and investment markets in the March quarter. Rarely does any single issue wholly dominate economic and market data for a quarter. Yet COVID-19 arrived and wiped away focus on any other issue.  Apart from the oil war, which itself was relegated to almost irrelevant, there was essentially no other theme that had an influence on shaping the quarter globally.

In the US, confirmed cases of Covid-19 rose from 150 to over 100,000 between the first and last weeks of March. Jobless claims increased by over three million in the last week of March and economic indicators suggest more pain is coming. The Federal Reserve cut interest rates twice during March for the first time since the global financial crisis and announced unlimited quantitative easing (buying bonds). The US Senate passed a $2 trillion stimulus package, including $250 billion worth of direct payments to households, $500 billion for loans to distressed companies and $350 billion for small business loans.

It was a similar story in the Eurozone. Nations took steps to restrict the movement of people and shut down parts of the economy in an effort to slow the spread of the virus. Italy and Spain were the most severely affected countries. Growth was already scant, the Euro economy grew by just 0.1% in Q4 2019, with Germany registering zero growth. In response to COVID-19 the European Central Bank announced a €750 billion scheme to fund the purchase of government and corporate bonds until the end of the crisis. Governments across Europe also announced spending packages to help businesses and households who have lost income.

In the UK, the pound hit multi-decade lows against the US dollar. As with other central banks, the Bank of England cut interest rates, cutting by 65 basis points to 0.10%. This response was co-ordinated with the UK government, which unveiled an unprecedented series of fiscal support measures, in line with initiatives by many other developed nations.

In Japan the virus spread has been on a different trajectory to many other developed nations with a slower spread and lower mortality rate. This has resulted in a slightly less stringent response from the authorities so far. From late March, however, there have been more forceful requests from both central and local governments to curtail social activities. The largest issue for Japan has been the postponement of the Tokyo Olympics. Now scheduled for July 2021. Although this is not particularly significant in economic terms, with maybe 0.2% of GDP shifted from this year to next, the Games are now planned just before the next Japanese election in October 2021.

China, the first country to record cases of COVID-19, took measures to lock down the city of Wuhan. Its measures to contain the spread were deemed a success as the number of active cases of COVID-19 in mainland China appeared to peak in February, and subsequently fell sharply. A mixture of interest rate cuts and fiscal (tax and spending) measures were also announced during the quarter.

Back in Australia, the December quarter figures came through with economy growing at 0.5%, with 2.2% in total for 2019. This is all ancient history now, with bushfires and COVID-19 to send growth into negative territory. The RBA first cut the cash rate on March 3 to 0.5%, then followed with another reduction to 0.25% on March 19, along with announcing various liquidity measures including purchasing 3-year government bonds.

Market Overview

Asset Class Returns

The following outlines the returns across the various asset classes to the 31st March 2020.

Shares across all markets suffered steep declines in the March quarter, while government bond yields fell (prices rose) as investors favoured their perceived safety. US equities declined significantly over the quarter as the coronavirus outbreak spread. Every US sector saw significant declines. Energy stocks were hit hard, with the oil price war weighing heavily. Financials and industrials also fell sharply. The information technology and healthcare sectors held up better, albeit with steep falls.

It was no different in the Eurozone, with shares experiencing a sharp fall in March quarter due to the spread of COVID-19. Financials and industrials were the worst hit sectors. Regulators have pushed for European banks to suspend dividends and share buybacks temporarily. This would help increase their capacity to manage rising non-performing loans as borrowers struggle with repayments.

UK shares tumbled as efforts to deal with COVID-19 hit economic activity indiscriminately. Prior to these events, domestic politics and Brexit had dominated UK markets and the economy for the quarter. At the height of the market sell-off, all assets (including government bonds) fell amid fears around the stability of the financial system.

After a relatively stable start to the year, the Japanese market fell steeply in late February and early March before recovering some ground to end the quarter. Asia ex Japan shares declined sharply in the first quarter, as Covid-19 became a pandemic and the prospect of a global recession loomed. US dollar strength was a drag on returns

In contrast, China recorded a negative return but outperformed the MSCI Emerging Markets Index as the number of Covid-19 cases declined, and economic activity began to resume.

In Australia, the ASX was not immune. Having risen about 7% in the first seven weeks of the year to reach record highs on 20 February, the Australian share market fell 37% in just over a month. That period included three of the biggest single day drops in history. It recovered some ground in the final week of March, but still ended the quarter down more than 23% – its worst quarterly performance since the crash of 1987.

The large four banks were some of the most heavily punished names on a price basis. NAB, Westpac and ANZ all suffering 30% plus falls. Only CBA slightly better with a 22% fall. To add insult to injury, rumblings about the banks cutting their dividends started. Doing their best to hold ground over the quarter were the large supermarkets who saw an increase in demand as consumers stockpiled. Australian listed real estate was pummelled as other retail businesses closed, with some making threats not to pay rent.

COVID-19 Stimulus Package Update

The news around COVID-19 continues to move fast. Governments are moving to alleviate the impact on individuals and businesses. Today’s stimulus had the following measures included.

SUPPORT FOR INDIVIDUALS

Welfare payments: $18.1bn

Welfare recipients receive an extra $550 a fortnight on top of their current benefits, essentially doubling the newstart payment.

Coronavirus supplement time-limited for next six months.

Waiting times and asset tests for JobSeeker Payment waived.

Extra one-off $750 payment for welfare recipients and veterans, on top of the $750 announced for them in the last round of stimulus measures. The 2nd $750 will arrive in July.

Superannuation: $1.2bn

Unemployed, casuals and sole traders will be able to access their superannuation funds.

People can apply to access up to $10,000 in this financial year. Another $10,000 will be accessible in the next financial year.

Minimum superannuation drawdown rates for retirees and others reduced by 50 per cent until 2021.

Deeming rates: $876m

Deeming rates lowered in line with the Reserve Bank’s emergency rates cut.

Expected to benefit up to 900,000 pensioners.

SUPPORT FOR EMPLOYERS: $31.9BN

Jobs payments

Small and medium enterprises (SMEs) to get up to $100,000 to keep staff in jobs.

Payment linked to business PAYG Withholding. 100 per cent of tax businesses withhold from staff’s wages: the more staff you have, the more money you get back (up to a limit of $100,000).

Businesses with turnovers of up to $50m and charities eligible.

Cash flow for SMEs

Cash flow injection into small businesses from last stimulus package boosted.

Minimum payment rises from $2000 to $10,000. Maximum payment from $25,000 to $50,000.

WIDER SUPPORT FOR BUSINESSES

SME loan guarantee: $20bn

Federal government will guarantee 50 per cent of loans to small businesses.

Government guarantee will support up to $40bn of banks’ lending to SMEs.

Insolvency and bankruptcy

Threshold for creditors to take action raised from $2000 to $20,000.

Businesses will have six months, instead of 21 days to respond to creditors.

Further information and fact sheets are available at https://treasury.gov.au/coronavirus

Coronavirus and recent market falls

When the market falls 7% in a day. There’s no sugar coating it. It’s very painful.

What now?

We’ve been through this many times before. Our experience tells us to do nothing. With every previous market fall there has been a recovery. Every financial adviser has a story. It’s the person who panicked. There was an event. There was a large market reaction and a client demanded to exit their portfolio and sit in cash. These clients never get back in. They sit in cash as the market recovers.  Then it pushes higher. Too proud they refuse to reenter. Often they descend into conspiracy. Clutching for the next ‘event’ that will send markets further down.

Days like this will lead every news bulletin. They will be plastered on every front page. It’s to be expected. Unlike most other falls, one this size is genuine news. However, there’s nothing for any investor to gain by rehashing it. Our advice would be turn it off. It will be spun into ‘the end of days’ and it will be cheap entertainment.

The good news? It’s cold comfort, but the falls in sharemarkets are being partially offset by a wave of money flowing into bonds or fixed interest. Portfolios are built with fixed interest as the buffer or stability that offsets sharemarket falls. The money flowing into fixed interest is pushing up the price and the yield down. A properly constructed portfolio is behaving as it should under the circumstances.

For anyone holding more fixed interest than shares in their portfolio, it’s slightly more benign. This has likely affected you much less than what you’re seeing in the media.

The bad news? No one knows anything. Nor how long this may drag on for. A cure could come tomorrow. The response to that could be a swift turn around. Those who panic and exited the market for safety will pay a price. It happened in 2009. After the dust settled a recovery was swift.

Investing is relatively simple – if we do nothing. The hard part is doing nothing. Instead of focusing on market movements it’s best instead to reflect on our financial plan and reflect on our goals. While days like this aren’t welcome, our portfolios are built in support of our goals. In line with the level of risk we were willing to take pursuing them.

Those goals and plans aren’t likely to change. With that in mind, an exit to cash, which offers almost no return, cannot and will not support goals over the long term.

Here’s a history lesson on why, providing you portfolio is correctly constructed with regard to your personal circumstances, doing nothing is preferable to acting.

In the last decade one of the most brutal and unrelenting sell offs came in 2011. On March 11 a magnitude 9.0 earthquake occurred off the pacific coast of Japan. The earthquake was quickly followed by a Tsunami and a Nuclear power plant melt down. No one knew what any of this meant. Shares sold off and kept selling off.

Later in the year the US lost its AAA credit rating from S&P. Two major events in the space of six months. While there were brief upswings along the way, from 11 April 2011 until 4 October, the ASX All Ordinaries fell 22% without accounting for dividends.

How did things look on a monthly basis in 2011? There was a lot of red in sharemarkets while fixed interest acted as a stabiliser.

But what happened after 2011? As is often the case, the recovery followed. There were double digit gains.

What did 2011 & 2012 look like together?

Over that two year period, 2012’s recovery offset the continuous falls of 2011.

We don’t know how long we might have to endure the current falls, but it’s important to remember there is always a recovery. As strange as it sounds the sharemarket is likely becoming less risky, not more. Expected returns go higher when markets go lower. This is why it is important to avoid making any rash changes. The virus will eventually have a cure. The situation in the oil market will stabilise. Governments will act to stimulate their economies. Action will be taken. Countries will return to normal.

All of these things combined will ensure the recovery starts and advances. There will be hiccups, but it’s important not to be on the sidelines when a recovery begins. Remember, a recovery only becomes a recovery in hindsight – when the market is substantially higher. You won’t know it when you see it, but a year later it will be obvious.

Our experience has shown it’s impossible to accurately time such movements. The reason why it’s best to stay the course.

This represents general information only. Before making any financial or investment decisions, we recommend you consult a financial planner to take into account your personal investment objectives, financial situation and individual needs.

December Quarter Review

Economic Overview

The geopolitical risks that dominated for much of 2019 faded in Q4, supporting global share markets. Trade uncertainty faded with the US and China’s phase one trade deal announcement, while economic data remained stable. The trade deal, signed on January 15 means planned new tariffs will not be imposed, while US tariffs imposed in September on $120 billion Chinese goods will be reduced by half. The 25% tariffs on $250 billion of Chinese goods will remain. China also agreed to increase purchases of US goods, with agricultural produce highlighted.

The US Federal Reserve cut interest rates once in the quarter before indicating that “the current stance of monetary policy is appropriate”. The US economy expanded by 2.1% (annualised) in Q3. A result better than expected and stronger than Q2.

In the Eurozone, the confidence measure among German executives, improved in December, yet the Eurozone purchasing managers’ index remained unchanged at 50.6 in December – a level that indicates weak growth. Annual inflation was 1.0% in November, up from 0.7% in October but still well below the European Central Bank’s target of close to 2%. Christine Lagarde, in her first major speech as president of the European Central Bank, urged governments to boost public investment in order to increase domestic demand in Europe.

In the UK, the Latest GDP figures confirmed the economy had avoided entering a technical recession in the third quarter after contracting in the previous quarter. GDP growth was 0.4% quarter-on-quarter. Overall, the data suggests that the economy is coping with the uncertainty from Brexit. After the landslide election victory for the incumbent Conservative Party, the government is set to use its large majority to take the UK out of the EU by 31 January 2020, entering a transition period when the next stage of negotiations will begin

Japan’s economic data continued to show a significant divergence between the strength in service sectors and the weakness in manufacturing. There were also signs that the long-running trend towards an ever-tighter labour market had finally reached its natural limit. The main economic event for the quarter was the consumption tax increase on 1 October.

In Australia, the RBA cut the official cash rate to 0.75% in October. Despite predictions of further cuts, none eventuated during the quarter. Eyes now turn to the RBA’s first meeting in February. While the RBA noted in its December minutes that, “the Australian economy appears to have reached a gentle turning point” it also finished those minutes by noting, “the Board is prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time.”

Market Overview

Asset Class Returns

The following outlines the returns across the various asset classes to the 31st December 2019

Overall, it was a mixed quarter to top off an extremely strong year. The majority of the Q4 gains came from global shares. US markets pushed higher as trade uncertainty faded, while Eurozone markets advanced with better economic data emerging from Germany. Bond markets reflected the better mood in the quarter as government bond yields rose (prices fell) and corporate bonds performed well.

Across the year it was hard to miss a good return, both Australian and global shares returned 20%+ returns, while Australian listed property was pushing 20% and fixed interest was given a shot in the arm as yields fell and prices increased. The asset class doing no one any favours? Cash.

In the US, the tech sector was a major beneficiary of easing trade tensions. Energy companies, which had lagged the broader S&P 500 index in 2019, rallied as the oil price rose on lower-than-expected supply.

Eurozone shares notched a strong return in the final quarter of the year, with the region’s MSCI EMU index returning 5.1%. Listed companies were supported by better economic data from Germany as well as the phase one trade deal agreed by the US and China. Gains were led by sectors that generally fare well when the economy is strengthening; top performing sectors included information technology, consumer discretionary and materials.

UK equities performed relatively well, and domestically focused areas benefited significantly as they responded favourably to the reduction in near-term political uncertainty.

The Japanese market rose in each month of the quarter to record a total return of 8.6%. Asia ex Japan delivered a strong return in Q4, supported by easing geopolitical risk as the US and China reached a phase one trade deal. US dollar weakness also provided support to returns. Against this backdrop China, South Korea and Taiwan all outperformed. In Taiwan, strong performance from technology sector companies boosted returns, as earnings expectations were revised upwards following solid Q3 sales figures

Emerging market shares posted a strong gain in Q4, benefiting from easing geopolitical concerns. The MSCI Emerging Markets Index increased in value and outperformed the MSCI World.

After a double digit first half of 2019, you might say the ASX coasted home with lower returns in Q3 and a meek 0.75% return for Q4. Notably, it did pass its previous record high in November. Q4 was hampered by a weak December with concerns over Christmas retail figures, the strengthening Australian dollar and improving employment figures, which paradoxically became a negative with the ASX counting on the support of further interest rate cuts. Meanwhile, three of the four big banks, NAB, ANZ and Westpac, struggled through Q4 with either more scandal or cuts to earnings and dividends, proving another drag for the ASX in Q4.

2019 Take outs

As we’ve noted, it was hard to go wrong in 2019, unless you had a bank account stuffed with cash or a poorly diversified portfolio stuffed with bank shares – or worse, a combination of both! Major asset classes all delivered stellar returns and when combined into a balanced portfolio of 60% growth assets/40% defensive assets the return was 16.74% for 2019, after a 1.01% return in 2018. Remarkably, the 2017 return for such a portfolio was 8.17% and the 2016 return 8.01%.

How reliable is that consistency? The average annual return for this portfolio is 8.27% for the past decade. The worst return came in 2011 with a -1.00% return, with 2019 being the best. Which shows if you’re prepared to ride out the sub-par years the realignment can eventuate, along with the rewards.

The on again off again trade tensions have proven somewhat farcical. A sniff of negative would take the market down and a whiff of positive would drag it back upwards. When the trade issues move into the background it will be interesting where global markets will take their cues from next. The US presidential race will likely be a focus. Just remember 2016 and the damage Donald Trump was supposedly going to inflict on world markets.

Whatever the focus, it should remain as a matter of interest, not a matter of concern. 2019 was a reminder that we should never react because our expectations may not align with market responses. There was significant concern as 2018 ended. Economic momentum was slowing, earnings growth was in question and optimism was low.

2019 returns were unexpected and more than anyone could hope for.

Does it mean anything for 2020? No. 2020 will have no memory of 2019, just as 2019 had no memory of 2018.

Are you getting your stockmarket news from the mainstream media?

One of the main things I tell my clients once we have carefully invested their money is to stop listening to what they hear on the news. Many people feel you need to carefully listen to the finance report to have your ‘ear to the ground’ as a ‘savvy investor’. It’s actually the opposite. You need to have a long term plan and discipline not to react to everything you hear.

He is a little video with a few finance report sound bites from the last year.

We've all heard about the "billions wiped off the sharemarket" on down days, but down days constitute about 33% of trading days. What happens the rest of the time? Well the media's not telling you the full story.

September Quarter Review

Economic Update

It was a mixed quarter and economic data reflected that. Developed markets making small gains while emerging markets fell. The US-China trade dispute rumbled on, as did global growth concerns, but central banks remained supportive with the US, Australian and European Central Banks cutting interest rates throughout the quarter.

US economic data was mostly stable. Unemployment held at 3.7%, with wage growth in August stronger than anticipated. However, new non-farm job additions were lower than expected in August, at 130,000 versus predictions of 158,000. Consumer confidence also weakened. The US yield curve inverted, a phenomenon which often precedes recession and, in this instance, led to significant hyperventilating in the media.

Despite the ebb and flow of optimism over a trade war resolution, any concrete plans to solve the ongoing US-China dispute remain elusive. Increasing speculation over possible impeachment proceedings for President Trump added to uncertainty.

In the Eurozone, economic data remained lacklustre with confirmation that the economy expanded just 0.2% in Q2. Annual inflation was 1.0% in August, compared to 2.1% in the same month in 2018. Speculation over the possibility of further stimulus dominated, and in September, the European Central Bank (ECB) took steps to boost the economy. Measures taken included restarting quantitative easing and committing to buying assets until its inflation target is reached.

In the UK, Brexit and domestic political uncertainty remained elevated. Boris Johnson took over as the UK’s new prime minister on a “do or die” pledge to achieve Brexit. He followed this up by saying he’d rather be “dead in a ditch” than ask the EU for an extension to the country’s EU departure date. However, legal developments increased expectations that a “no deal” exit on 31 October would be averted.

In Asia, Chinese authorities announced fresh policy support in response to domestic weakness. Meanwhile the US announced new tariffs on $300 billion of goods imported from China which did not already face a levy, some of which took effect in September. In South Korea, a trade dispute with Japan weighed on sentiment somewhat.

In Australia, east coast house prices began to stabilise after a series of interest rate cuts from the Reserve Bank in conjunction with a relaxation of mortgage lending rules. However inflation remained subdued along with consumer spending. Recent tax cuts, coupled with lower interest rates, have seemingly had little impact encouraging consumers to spend. Policy response remains muted as the Federal Government remains focused on a budget surplus.

Market Overview

Asset Class Returns

The following outlines the returns across the various asset classes to the 30th September 2019.

US equities posted modest gains in Q3, despite ongoing growth concerns and never-ending uncertainty surrounding US-China trade. Utilities, real estate and consumer staples were amongst the quarter’s better performers. Energy and materials were weaker areas of the market, given expectations of a more challenging demand environment. Healthcare remains a matter of heated debate in the run-up to the 2020 US presidential election, and the political sensitivity caused the sector to lag the market.

Eurozone shares made gains in the quarter. Amid ongoing worries over trade wars and global growth, the best-performing sectors included utilities, real estate and consumer staples. Underperformers over the quarter were energy and consumer discretionary. However, the market saw a rotation in September with financials, which had previously been out of favour this year, leading the gains.

UK equities recorded modest gains in what was a mixed quarter. Amid concerns about the world economic outlook, many investors favoured assets perceived to have defensive qualities. These included so-called “quality growth” companies which are characterised by their superior and defensible earnings growth. In contrast, many economically sensitive areas of the market performed poorly, including the UK’s heavyweight financial and commodity sectors.

Asia ex Japan shares lost value in Q3 amid renewed intensification of US-China trade tensions and rising concerns over global growth. The MSCI Asia ex Japan Index fell -4.5% and underperformed the broader MSCI World index. Hong Kong was the weakest index market, as demonstrations continued, despite HK government’s efforts to resolve social unrest. Malaysia, Singapore and Thailand all posted negative returns and underperformed.

Emerging market equities were down as US-China trade tensions escalated and concerns over global growth continued to mount. The MSCI Emerging Markets Index decreased across the quarter also underperforming against the MSCI World index.

Back in Australia, an interest rate cut left cash returns at almost negligible levels, though still better than negative rates elsewhere. All other asset classes provided positive returns for the quarter with unhedged global shares and global real estate offering the strongest returns. The performances of the major iron ore miners such as BHP, Rio Tinto and Fortescue were weaker in Q3, as the previously booming iron ore price fell. Most notable was a mid-quarter pullback on US ‘recession fears’. After a two-week tumble in August, a recovery quickly followed and by mid-September, Australian shares were above their quarter starting point. Once again, proving short term noise is best ignored.