A new economic environment

23 June 2022

After years of low inflation and low interest rates, we have finally entered a new period in the economic environment of higher inflation and higher interest rates. But how high will inflation be and by how much will interest rates rise? Periods of transition from a market perspective increase uncertainty and subsequently increase market volatility.

Market Developments during May 2022 included:

Australian Equities 

The Australian share market finished May 2022 with the S&P/ASX 200 falling sharply by -2.6% and ten out of eleven sectors finishing lower.   The Materials sector was the only positive finisher for the month (+0.1%). The Property (-8.7%) and Information Technology (-8.7%) sectors led the sell-off as persistently higher inflationary figures, geopolitical tensions and tapering fears supressed equities.

The Materials sector outperformance was primarily driven by the Ukraine and Russia geopolitical situation given the significant disruption to supply within commodity markets. The Property sector suffered heavy losses as investors evaluated the commencement of the tightening monetary policy for the first time in over a decade. Likewise, the rout in the Information Technology sector continued as rising interest rates worldwide and potential recessionary fears subdued growth stocks. 

Overall, the sharp decline was triggered by a mixture of elevated inflationary figures arising from the ongoing Ukrainian conflict, Chinese lockdowns, and the ensuing monetary policy response from central banks worldwide. 

This scenario has continued into the first weeks of June and we have seen the Australian S&P/ASX200 fall by more than 600 points – month to date.

Global Equities

Downward velocity in global markets tempered over the month of May as the war in Ukraine endures, inflation continues to escalate and Covid restrictions in China persist. Developed markets marginally fell by -0.8% by month end, Global small caps didn’t fare as well as their large cap counterparts closing with a -1.5% loss. Emerging markets performed similarly to the previous period falling by -0.5%, whereas Asian markets posted a modest gain of 0.2%.

Investor sentiment continues to be challenged by geopolitical risk and inflation pressures as central banks contemplate the pace and quantum of rate rises required to stem the tide of rising costs of living. 

June has seen further falls, mainly in response to a higher than anticipated move by the US Federal Reserve to increase interest rates by 0.75% as they battle to rein in higher than expected inflationary pressures.

Fixed Interest

The past month has seen a continued rise in bond yields, following The Reserve Bank of Australia raising the cash rate on May 3rd by 25bps to a 0.35% cash rate. With higher yields across the curve, combined with the outlook of risks to growth, bonds are again beginning to show some of the benefits of diversification in a portfolio. Since the start of May, Australian 2 Year Government Bonds have increased by 2bps while Australian 10 Year Government Bonds rose by 22bps as at the end of the month. 

A subsequent rate rise on 7 June saw the Australian official cash rate increase to 0.85%.  This was followed by a higher than expected increase by the Federal Reserve in the US.  Further rate rises are anticipated.

REITs (listed property securities)

Local and Global REITs sold off during May. Domestically, the A-REITS Index (represented by the S&P/ASX 200 A-REIT Accumulation Index) ended the month -8.7% lower, the second worst monthly performance since May 2020, with January of this year taking first prize (-9.5%). The Index has returned -14.7%on a total return basis YTD to 31 May. 

Global REITs outperformed the local REITs index, albeit still experiencing a drawdown of -4.5% during the month. Domestically, infrastructure (represented by the S&P/ASX Infrastructure Index) has continued its divergence from A-REITs, returning 1.2% in May and 16.9% YTD. A large driving force behind the divergence may be explained by the high levels of financial leverage common across the REITs sector.

Growth continued to slow across the residential domestic property market during May, with Sydney, Melbourne, and Canberra all returning negative returns of -0.1%, -0.7% and -0.1%, respectively. Adelaide experienced the largest increase of 1.8% for the month. The 5 capital city aggregate changed by -0.4% MoM. (CoreLogic)