Your Finance Update - February Summary
Over the course of 2022 our message to investors has been simple. Markets are in a period of transition and with transition comes some pain. The rapid shift from record-low interest rates and liquidity-fuelled markets, to one of higher interest rates and central banks shrinking their balance sheets has impacted markets. This has been coupled with the ongoing effects of Covid on economies, notably China and the unexpected conflict in Ukraine. Both events contributing to rising inflation which has been the topic du jour for all of 2022.
We should hit peak inflation in 2023. Central banks around the globe have been aggressively raising rates to curb inflation. In Australia, the December CPI figure hit 7.8% with the cash rate target reaching 3.10%. Cyclical indicators have been broadly trending down and we are yet to see the full impact of rate rises on households. We believe that demand will show more material signs of slowing in the second and third quarter of 2023, which should see inflation stabilise.
The inverted yield curve is suggesting that a recession is on the cards. Historically, recessions have occurred 12 to 18 months after the yield curve has inverted. While the likelihood of a recession is elevated, the relatively strong labour market is expected to reduce the risk of a deep prolonged recession. We do however expect segments of the economy to be hit harder than others, such as the construction industry, which has already experienced a downturn following rises in interest rates. Conversely Australia’s exposure to materials and the reopening of China from strict Covid lockdowns is expected to benefit things such as iron ore exports.
We are yet to see the full impact on demand of interest rate rises. While the savings ratio has been declining as households increasingly dip into their savings, households are still spending, with travel spending being the big winner. However, our expectation is that we will observe a slowdown in demand in the second half of the year as many household budgets get a jump in their mortgage repayments as their fixed rate loans roll-off and they move towards the higher variable rate. This should see a slowdown in discretionary spending which should show up in company earnings later in the year.
Range trading market
Markets have started 2023 on a positive note. Some of acute issues that adversely impacted markets in 2022 have subsided. Energy prices, which rose sharply following the Russian invasion of Ukraine have fallen with European gas prices falling by over 27% in January alone. Furthermore, the consumer is still buoyant despite higher interest rates.
As 2023 progresses and the impact of rising rates makes its way through the economy and company earnings come under increased pressure, we may see the market pull back. Net-net it is plausible that 2023 may be a relatively flat market characterised by spikes in volatility both to the upside and the downside.
Market Developments during January 2023
Australian Equities
The Australian market commenced the year convincingly, with the S&P/ASX 200 Accumulation Index rising by 6.2% and every sector finishing positively apart from the Utilities (-3.0%) sector. The gain represents the best start to the year since the inception of the Index. The Consumer Discretionary (+9.9%) and Materials (+8.9%) sectors led the market, as investor optimism around the future cash rate and inflation trajectory in an Australian and global context buoyed the broader market.
The Utilities sector was the biggest laggard as investors pivoted away from more defensive sectors in favour of more cyclical exposures. The Consumer Discretionary sector performed robustly as companies reported earnings. The Materials sector performed strongly as several commodities continued their recent rally on the back of the China re-opening demand. Further, the volatility in the Australian market was relatively subdued. Broadly speaking, the more ‘growth’ oriented and interest-rate sensitive sectors exhibited solid performance as investors weighed up the potential for central bank policy rate cuts in Australia and other global economies.
Global Equities
Global equities started on a positive note as optimistic views around inflation fed through to possibilities around a reduction in central bank tightening. Emerging markets outperformed developed market counterparts returning 3.8% (MSCI Emerging Markets Index (AUD)) versus a 3.0% gain according to the MSCI World Ex Australia Index (AUD).
Investor confidence was elevated during the month as global macro data surprised to the upside combined with China reopening earlier than expected. This was reflected by the Hang Seng Index and the CSI 300 Index, returning 10.4% and 7.4% respectively (in local currency terms) for the month. In the US, over a third of companies have reported, with earnings in aggregate being 0.6% above consensus and the S&P500 Index posting a monthly return of 6.3% (in local currency terms).
In Germany, the DAX 30 Index reported a gain of 8.7% for the month (in local currency terms) as it continued to benefit from the easing of supply disruptions, a decline in the risk of gas rationing and further fiscal support.
Fixed Interest
With no RBA meeting in January, there has been a pause on rate hikes, with rates expected to rise once again in February. This led to Australian 2- and 10- year Government bond yields falling by 23bps and 50bps, respectively. The fall in bond yields resulted in almost every fixed income sector being in the green, resulting in the Bloomberg AusBond Composite 0+ Yr Index to return 2.7% over the course of the month. Inflation has now risen to 7.8%, over the past 12 months to December, and CPI rose 1.9% this December quarter according to ABS data.
Subsequently the RBA increased rates at their 7 February meeting by 25 basis points to 3.35 per cent. The December inflation figures were cited as a factor in this increase and the RBA observed that GDP growth, a tight labour market and wages growth are also factors being taken into consideration when making interest rate decisions.
Globally, fixed income markets showed a mixed story, with US markets bracing for another rate hike in the next Federal Reserve Meeting on February 1. US 10-year Bond yields rose 37bps and US 90 Day T-Bill yields rose 30bps. In the United Kingdom, markets also await the return of the BoE meetings in February, with the current January bank rate sitting at 3.50%. Over January, U.K. 2 Year Gilt yields fell 11bps and U.K. 10 Year Gilt yields by 34bps.
REIT’s (listed property securities)
The S&P/ASX 200 A-REIT Accumulation index had a strong start to the calendar year advancing during January, with the index finishing the month 8.1% higher. Global real estate equities (represented by the FTSE EPRA/NAREIT Developed Ex Australia Index (AUD Hedged)) also finished strongly, advancing 8.2% for the month. Australian infrastructure performed well during January, with the S&P/ASX Infrastructure Index TR advancing 1.9% for the month.
The positive start to the year is a welcome sight for REIT investors, as the listed property sector suffered a material decline in 2022. 2022 was the worst-performing year for REITs since the global financial crisis. Capital raising is expected to be a prominent theme in Q1 this year with the significant change in debt markets and cost of capital. In the global REITs market, we have already seen eight capital offering instruments in January, raising a total of $4.1bn in capital, in contrast to the $250m raised in December.
The Australian residential property market experienced a –1.1% change month on month in January represented by Core Logic’s five capital city aggregate. Brisbane (-1.4%), Sydney (-1.2%), Melbourne (-1.1%) and Adelaide (-0.3%) all performed poorly whilst (0%) stayed relatively neutral.
