Can we have boring please?
It sounds like a cliché but there is never a dull moment in markets. Not too long ago most people were unaware of what SVB (Silicon Valley Bank) was. Today everyone is an expert with reams of analysis as to where it all went wrong!
It has been a tumultuous month for markets starting with several small/mid-sized banks in the US shutting down and depositors redeeming their money as questions about the viability of these banks gained momentum. This was topped off with one of the cornerstone establishments of Swiss banking, Credit Suisse, being bought out by UBS to avoid a banking collapse and possible contagion across the global banking sector. The story didn’t end there as Credit Suisse AT1 debt holders (equivalent to Australian hybrids) got wiped out with assets being written down to zero while equity holders retained some value. This put the whole notion of the capital structure into question where debt holders are meant to rank above equity holders which created more volatility in markets and forced the European Central Bank and the Bank of England to come out to reassure markets by stating that the traditional capital structure remains true and that the Credit Suisse AT1 debt issue is isolated to Switzerland’s unique banking rules.
For many the current banking melodrama is invoking bad memories of the global financial crisis (GFC) of 2008. It is important to note that the banking sector has significantly de-risked since 2008 notably in terms of Tier 1 capital ratios which have increased substantially since 2008 following the Basel III banking framework which was brought in post the GFC in order to strengthen the banking system. One of the issues with banks such as SVB was a lack of governance and oversight by the US regulator, which contrasts with the Australian banking sector which has largely adopted the Basel III requirements. Another notable difference from the GFC was that central banks reacted quickly to the current crisis, unlike in 2008 where central banks dragged their heels until the banking system was on the verge of breaking.
So, are we out of the woods? It seems that the swift action of central banks has settled markets for now. The broader risk remains contagion and like many significant events in history while they don’t necessarily repeat, they do rhyme. There is no doubt that there are many nervous bankers out there taking a good look at their business models and capital reserves.
From a practical perspective we would expect the cost of debt to rise as a result of the banking issues. There is a view that this would in effect be the equivalent of two rate hikes and that it may trigger central banks to take a more dovish stance in raising rates to fight inflation. To date there is no evidence of this and central bank commentators have tried to delineate between stability of the system and inflation. However, one cannot dismiss the notion that the rapid rise in rates has exposed cracks in the markets with the current banking issues an example of this.
Market Developments During March 2023 included:
Australian Equities
The month of March ended with the S&P/ASX 200 Accumulation Index down -0.2%. The primary driver was the uncertainty arising from bank failures in the US and Europe. This, coupled with high, albeit easing, inflation added to investors’ uncertain market sentiment. The Materials sector (+5.9%) rebounded with Communications (+3.4%) also performing strongly while the Property (-6.8%) and Financials ex-Property (-4.9%) sectors were the worst performers. Over the quarter, Consumer Discretionary (+11.4%) was the best performing sector.
Materials led all sectors for the month, reaping the benefits of higher commodity prices. The Property sector sold off following concerns around commercial real estate valuations, which stemmed from investor sentiment around higher interest rates and macroeconomic headwinds. Meanwhile, the collapse of major overseas banks led to selloffs within the Financials ex-Property sector. Overall, investors grappled with the inflation-driven interest rate outlook facing central banks globally and its implications on future economic outlook.
Global Equities
Global equities rallied after a sharp initial decline for the month, led by volatility across the Financial Services sector, notably Silicon Valley Bank and Credit Suisse. This was alleviated with expectations of potential easing in central bank tightening via the US Fed’s dovish outlook commentary for the year. Emerging markets performed similarly to developed market counterparts returning 3.7% (MSCI Emerging Markets Index) and 3.9% (represented by the MSCI World Ex Australia Index) in Australian dollar terms, respectively.
Investor confidence was maintained as relatively positive, with global macro data continuing to the upside. Mixed performance was seen across Asia with China posting fresh economic stimulus geared towards growth, as well as varied reception to the Fed’s dovish comments. This was reflected by the Hang Seng Index and the CSI 300 Index, returning 3.5% and -0.5%, respectively (in local currency terms) for the month. In the US, indications of no further rate rise lead the rebound, with the S&P500 Index posting a monthly return of 3.7%
In Germany, the DAX 30 Index reported a gain of 1.7% for the month (in local currency terms) after posting decreasing manufacturing data indicating further weakness ahead, which was shared by the rest of the continent with the FTSE Eurotop 100 Index reporting similar returns of 1.0% (in local currency terms) for the month.
Fixed Interest
At the start of March, the RBA raised the cash rate target by 25bps to 3.6%, stating global inflation remains high and is expected to take some time before it returns to target rates, while growth in the Australian economy has slowed and is expected to be below trend. However, uncertainty within the global financial sector was reflected across the Australian 2- and 10-year Government bond yields which fell by 70bps and 56bps, respectively. Australian fixed income performed strongly during the month with the Bloomberg Ausbond Composite 0+ Yr Index returning 3.2%.
Globally, markets were jolted by the financial sector woes in the US and Europe, which significantly impacted financial conditions and bond yields during the month. In Europe, UBS's takeover of Credit Suisse caused turmoil in bond markets, with Swiss authorities allowing Credit Suisse's riskiest bonds to be wiped out, and equity holders receiving a small amount of equity in UBS as part of the transaction. The US 2- and 10- year Government bond yields fell by 80bps and 45bps, respectively. The Fed continued to raise rates for the ninth consecutive time to 4.75%-5%, demonstrating their commitment to ending the inflation problem despite the banking crisis. In the United Kingdom, GILT yields followed the US, as 2- and 10-Year Gilt yields fell 60bps and 22bps, respectively.
REITs (listed property securities)
The S&P/ASX 200 A-REIT Accumulation index continued to fall in March after selling off in February, with the index finishing the month –6.8% lower. Global real estate equities (represented by the FTSE EPRA/NAREIT Developed Ex Australia Index (AUD Hedged)) also regressed, returning -3.6% for the month. Australian infrastructure continued its positive momentum during March, with the S&P/ASX Infrastructure Index TR advancing 0.3% for the month.
The Australian residential property market increased by 0.8% month on month in March represented by Core Logic’s five capital city aggregate. Sydney (+1.4%) and Melbourne (+0.6%) were the best performers whilst Adelaide (-0.1%) was the only city to regress during March.
Can we have boring please?
It sounds like a cliché but there is never a dull moment in markets. Not too long ago most people were unaware of what SVB (Silicon Valley Bank) was. Today everyone is an expert with reams of analysis as to where it all went wrong!
