18 January 2023
Your Finance Update - January Summary
2022 – What a Year! 2023 - What can we expect?
As the saying goes, “what a year!” As the world slowly emerged out of Covid lockdowns, two central themes have dominated 2022, inflation and geopolitics. Domestically the annual CPI figure has exceeded 7%. It has been a similar story across most economies globally. Years of low interest rates, central bank driven liquidity in the form of quantitative easing, severe supply chain disruptions caused by Covid lockdowns and the Russian invasion of Ukraine placing pressure on commodity prices have all contributed to the current inflationary environment. As a result, interest rates have gone up, with key central banks committed to raising rates until inflation shows signs of abating. The rising interest rate environment has fuelled volatility in markets, with no asset class spared, as assets have repriced for the higher interest rate environment. Needless to say, it has been a challenging time for diversified portfolios as equities and bonds have both sold off.
Additionally, as the market has tried to digest the prospect of higher inflation, we also witnessed a sharp rotation into sectors and stocks that were viewed as being beneficiaries of higher inflation. This is evident in the surge in energy stocks, with sectors such as healthcare and technology selling off irrespective of the quality of the company.
Despite the challenging market environment there have been some bright spots. Alternative assets have generally benefited from the increased market volatility and dispersion in returns. Unlike traditional assets, higher volatility is more conducive to alternative strategies, such as relative value approaches, as they can exploit market inefficiencies. Value-based investment approaches have also turned around a decade of underperformance relative to growth-style investing as growth stocks, which are viewed as longer duration assets, have been sold off. We have also seen many active approaches able to add value in this challenging period for markets as active investment managers have been able to sift through the market as assets have indiscriminately sold off. Finally, bonds which have been difficult to invest in for years due to the low interest rate environment are beginning to show signs of value as bond yields have risen.
In 2023 the themes of inflation and heightened geopolitical risk are expected to continue to be key focal points. However, the narrative will increasingly focus on the prospect of a recession as the impact of higher interest rates makes its way through the economy impacting households and ultimately demand which we expect will make its way to corporate earnings by Q3 in 2023.
At this stage our base case is not for a deep recession in Australia. However, on a global level Europe remains at greater risk of a deep recession as high inflation combined with energy security concerns resulting from geopolitical risks associated with the war in Ukraine continue to impact European markets. Central banks appear to be comfortable with the prospect of a recession as long as inflation is controlled. Against this backdrop we have been gradually neutralising our key active asset allocation exposures away from risk assets in favour of bonds.
The year ahead will be challenging with markets likely to range trade. Our dynamic asset allocation has added significant value over recent years as the decision to be long equities and underweight bonds was a relatively simple one. We expect that bottom up manager and stock selection will be a greater contributor to returns in 2023 as we continue to see increased dispersion in returns within asset classes as market volatility remains.
Market Developments during December 2022
The Australian market concluded the year with the S&P/ASX 200 Accumulation Index falling by -3.2% and every sector finishing negatively. The Materials (-0.9%) and Utilities (-1.2%) led all sectors, as the broader market ‘Santa Claus Rally’ faded in December and investors evaluated potential global macroeconomic uncertainty moving forward into 2023.
The Consumer Discretionary (-7.0%) and Information Technology (-5.4%) sectors were the biggest laggards as the prospect of further hawkishness from global central banks weighed on investors. The Materials sector was the most robust performer as commodities were relatively steady amidst China reopening optimism and higher gold spot prices. Despite the broader market sell-off, volatility was relatively muted as Australian investors repositioned themselves for 2023 after a strong month in November. In 2022, Energy (+49.0%) and Utilities (+30.0%) were the strongest performers, whilst Information Technology (-33.7%) and Property (-20.5%) were the biggest fallers. Overall, the broader market decline ultimately meant that the Australian market finished the year with a decrease of -1.1%.
Global equities ended 2022 with a monthly decline across most major indices. Emerging markets continued their relative strength against their developed market counterparts, recording a -2.6% loss according to the MSCI Emerging Markets Index (AUD) versus a -5.5% loss according to the MSCI World Ex Australia Index (AUD).
MSCI World Ex Australia Index (AUD) closed 2022 down -12.5%, and MSCI Emerging Markets Index (AUD) down -14.3%.
Across key global regions, there were few safe havens for investors to park their money, as the war in Ukraine, disordered supply chains, rampant inflation, and another year of Covid turned markets on their head. China’s CSI 300 Index had approximately one-fifth (-19.8%) of its valued wiped in 2022, followed closely by the USA’s S&P 500 index (-18.1%).
In its final meeting of the year, the Reserve Bank of Australia has again raised interest rates by 25bps bringing the target cash rate to 3.1%. Australian 2- and 10- year Government bond yields rose this month by 35bps and 52bps, respectively. The rise in bond yields resulted in almost every fixed income sector being in the red, resulting in the Bloomberg AusBond Composite 0+ Yr Index to return -2.06% over the course of the month.
The Australian unemployment rate however remains steady, supporting the growth outlook of the economy.
Globally, fixed income markets show a similar story, with US 10-year Bond yields up 27bps while US 90 Day T-Bill Yields remained relatively steady. On their December 14 meeting, The Federal Reserve raised the target federal funds rate to 4.25%-4.50%, with a rate hike of 50bps.
REIT’s (listed property securities)
Local and Global REITs sold off during December following two positive months. Domestically, the A-REITs index (represented by the S&P/ASX 200 A-REIT Accumulation Index) ended the month -4.1% lower. The index has returned –20.5% on a total return basis YTD to 31 December. Global REITs outperformed the local REITs index, albeit still experiencing a drawdown of –3.8% during the month. Domestically, infrastructure (represented by the S&P/ASX Infrastructure Index) has followed the trend in A-REITs, returning –1.44% in December bringing YTD performance down to 18.5%.
December was relatively quiet across the A-REITs sector. Some activity includes Dexus (ASX: DXS) announcing the sale of six properties with combined proceeds of $483m, two of which were trading properties. Centuria Industrial REIT (ASX: CIP) announced the settlement of a 50% interest in a portfolio of eight existing CIP assets for $180.9m to an investment vehicle sponsored by Morgan Stanley Real Estate Investing.
The Australian residential property market experienced a –1.2% change month on month in December represented by Core Logic’s five capital city aggregate. Brisbane (-1.4%), Sydney (-1.4%), and Melbourne (-1.2%) were the worst performers. Perth (+0.2%) was the only city within the five to advance. The %YoY change for Core Logic’s five capital city aggregate as of 31 December 2022 is –7.1%.