Market Update

Market Overview

After January’s strong start to 2023, February shifted into reverse gear with a softer performance across global markets. Central banks continued hiking interest rates despite global inflation prints beginning to show signs of abating. Softening in what has been exceedingly strong labour markets, as rate hikes weigh on confidence and household spending, is a clear indicator. That said, we are not out of the woods yet, as we believe there remains a long path to controlling inflation.

Another significant development observed is disruption. The introduction of artificial intelligence technologies like ChatGPT and other natural language processing tools earlier this year has generated significant attention and anticipation regarding potential productivity improvements throughout the technology value chain. However, these advancements have not yet led to any substantial revisions in Investment Managers, like Lonsec, long-term growth predictions. Developed markets continue to face considerable demographic challenges, including diminishing working-age populations and declining birth rates. The extent to which AI can profoundly enhance productivity—another pivotal aspect alongside population growth in growth rate projections—still remains uncertain.

Global markets are presently undergoing a phase of structural adjustment following the aftermath of the COVID-19 pandemic. Simultaneously, geopolitical dynamics are shifting, with China, a growing power, posing substantial challenges to the incumbent superpower, the US, across economic, technological, and military realms. Given these factors, there is possibility for heightened market volatility and broader variations in asset prices spanning different regions, sectors, and securities. This dynamic environment favours active management strategies.

Investment Valuations Summary:

• Presently, valuations appear equitable to moderately discounted in the realms of Australian Equities, Global Emerging Markets, and Real Assets. Conversely, US equities retain an expensive outlook both historically and relatively.
• While Global Listed Infrastructure seems reasonably valued when compared to equities, it appears costly in contrast to AREITs and GREITs.
• Government bonds maintain their appeal due to an increase in bond yields.
• The valuation landscape for various asset classes has improved, with Australian equities, European and UK equities, and emerging markets being reasonably or slightly underpriced based on Lonsec’s internal valuation model. Government bond valuations have also gained strength as bond yields rose in response to heightened inflation. This enhancement in relative valuation and risk-reward characteristics justifies our neutral allocation to Australian bonds.
• On the flip side, US equities remain relatively overpriced. Although Global Listed Infrastructure has shown relative resilience in the past year, its attractiveness from a valuation perspective has diminished.
• The trend of rising bond yields has enabled government bonds to offer more favorable value.

Economic Insights:

• Cyclical indicators signal a slowdown in economic activity for both Australia and global equities in the upcoming half-year period, though not of significant magnitude. In Australia, weak consumer confidence and building approvals persist. Consumers, having utilised much of their excess savings accumulated during the pandemic, are beginning to feel the strain from cost-of-living pressures and elevated interest rates. This strain is evident in the April retail sales figures, which remained stagnant. Household spending has receded across sectors, particularly in clothing/footwear, furnishings, and transport. Anticipated discomfort will arise as fixed rate home loans transition to variable rates in the near future. Corporations are also grappling with shrinking profit margins, a signal that they can no longer transfer the burden of elevated input costs. Surprisingly, residential property prices have demonstrated resilience despite tighter monetary policies. Strong housing demand has been bolstered by a resurgence in net overseas migration, taut rental markets, and sustained labour market tightness.

• Globally, PMIs continue to languish below 50, indicating contraction, although ISM Non-Manufacturing orders remain sturdy, underscoring the service sector’s relative stability compared to the goods sector.

Policy and Liquidity Outlook:

• The ongoing reduction in market liquidity, attributed to central banks trimming their balance sheets and moderating or ceasing bond purchasing programs, endures. Despite a short-lived uptick in liquidity following strains in the US regional banking system, central banks have resumed the trajectory of quantitative tightening. Coupled with banks enforcing more stringent lending standards, overall credit conditions have tightened.

Sentiment Snapshot:

• Brief-term sentiment indicators display a mixed panorama.

Developments in Financial Markets

Australian Equities

The ‘January effect’ seems to have taken place this year as December’s and February’s results were much softer. Though opposed to a well-known seasonal anomaly, January was put down to China reopening and an uplift in investor confidence, and February was over real concerns of sticky inflation and the potential need for further rate hikes. The S&P/ASX300 Accumulation Index shed 2.55% over the month, bringing the 1-yr rolling figure to 6.54%.

As for size, all small, mid, and large caps dropped, with large caps faring better this month. The S&P/ASX100 closed February down 2.91%, the S&P/ASX MidCap50 fell 3.73%, and the S&P/ASX Small Ords lost 3.70%. Small cap investors are still the worst off on a 1-yr basis posting a -7.97% return since the beginning of March 2022. This is somewhat expected as small caps are known to be more volatile with larger price swings compared to larger caps.

After being the worst performer in January, Utilities was the highest performing Australian sector over February with a 3.52% monthly return and is also the highest performer on a 1-yr basis, returning an impressive 23.26%.

Info Tech came in a close second for February with a 3.05% result (still at a 7.14% loss on a 1-yr basis). Coming in third yet again is Consumer Staples (2.65%), Industrials (1.32%), Telecommunications (0.93%), and Healthcare (0.15%). Loss-making sectors were Consumer Discretionary (-0.81%), Real Estate (-1.48%), Energy (-2.42%), Financials (-3.38%), and Materials (-7.82%). Energy is now the second-best performer on a 1-yr basis, returning 22.97% to investors.

International Equities

Global indices were more mixed over February, though much more subdued than January. The MSCI World Ex Australia (unhedged) gained 2.09% over the month, giving a -0.48% 1-yr rolling return.

Major US indices all closed red, with the S&P500, NASDAQ, and Dow Jones finishing the month down 2.44%, 1.01%, and 3.94% respectively. The 1-yr rolling results are slightly better than January’s but still nothing to write home about, with -7.69%, -15.96%, and -1.59%.

European markets sang to a different tune. The STOXX Europe 600 Total Return Index got a 1.74% bump, bringing the rolling 1-yr return into green territory at 1.77%. The French CAC40 gained 2.62%, the German DAX 1.57%, and the UK FTSE100 followed with a 1.35% bump. February’s results brought the 1-yr rolling figures up to 9.15%, 6.25%, and 5.60% respectively.

Asian markets were mixed, though Hong Kong had a significantly more troublesome month. The Korean KOSPI ended February down 0.50% (-10.61% 1-yr rolling) and the Japanese Nikkei 225 up 0.49% (5.79% 1-yr rolling). The Chinese Shanghai Composite and Hong Kong’s Hang Seng closed the month at 0.74% and -9.41% respectively. Both are still under a large amount of strain for the year, with their 1-yr rolling returns at -5.28% and -12.89% respectively.

Fixed Interest

Domestically, the Bloomberg AusBond Composite (0+Y) ended the month down 1.32%, bringing its 1-yr return down to -6.37%. International markets saw the Barclays Global Aggregate TR Hedged index fall 1.80% over the month and is still deep in negative territory with a -9.40% 1-yr rolling return.

10-yr bond yields rose substantially over February. Australia jumped 34bps to close at 3.90%, the US yield finished up 44bps to 3.95%, and the UK gained 43bps to 3.76%. Asian yields did not move much, with Japan rising a meagre 1bp to yield 0.5%, and China rising 2bps to yield 2.92%.

US credit spreads widened for high yield vs investment grade. The CDX North America (which is an index of credit default swaps) HY rose 35bps whereas the CDX North America IG rose only 5bps.

Foreign Exchange

The USD made some substantial gains over February, with its 1-yr performance against major currencies still unusually high. The Australian dollar shed 4.62% against the USD to end the month at 0.6729, this translated to a 7.35% drop for the year for the AUD.

The Pound Sterling and the Euro also lost ground against the USD over the month. The GBP/USD closed 2.42% down at 1.2022 (-10.42% 1-yr rolling), and the Euro finished down 2.64% against the Greenback at 1.0576 (-5.73% 1-yr rolling). The USD/JPY pair jumped 4.67%, closing at 136.17 (18.41% 1-yr rolling return).

Commodities

Commodity markets were soft over February. The Bloomberg Commodity Index, which tracks a broadly diversified set of energy, grains, metals, softs, and livestock futures, closed the month down 5.05% (posting a -7.33% 1-yr return). Oil softened, with Brent Crude dropping 0.71%, closing at USD$83.89, and WTI Crude slipping 2.31% to USD$77.05. Gold shed another 5.26% over the month to finish at US$1,826.92/oz. Iron Ore fell a further 0.85% on top of January’s 5.54% and December’s 15.24% to close at USD$116.87 per tonne – giving the mineral a 1-yr rolling result of -7.43%.