31 Oct 2023
The September quarter seemed to solidify calendar year 2023 as one akin to a washing machine – wash, rinse, and repeat. Again, interest rates and inflation were front and centre of market movements with short-term macroeconomic signalling / consensus (noise) changing every 30-45 days attempting to second guess where inflation, rates, and the economy might land in 2024 following the fastest period of rate hikes ever seen.
Whilst most market participants correctly called peak inflation and likely peak interest rates (maybe 1-2 more) early in the quarter, given most central banks either slowed the pace of rate hikes or began to pause. Conjecture began to rise as the pace and size of falls in inflation began to slow. The market narrative began to shift its focus from “inflation falling at a rapid pace” (as leading indicators pointed to impending recession and hence meaningful rate cuts in 2024) to concerns of inflation getting “stuck” above central bank targets (and potentially reaccelerating) due to resilient economies, with rates staying higher for longer.
These two narratives have quite distinct market backdrops and hence portfolio playbooks, resulting in volatility creeping up through the quarter as investors re-adjusted portfolio settings to account for the changing consensus.
The implications of higher rates for longer in light of inflation remaining stickier than expected is an interesting dynamic and hence a dilemma for investors. Is this time different, in that economic resiliency can be maintained or do higher rates for longer eventually lead to a more meaningful economic downturn?
We finally started to see the impact of higher rates and higher inflation in the quarter with cost-of-living pressures showing up in the data including weaker retail sales growth, falling household savings, excess discretionary spending capacity almost all gone, and borrowing costs catching corporates by surprise in terms of impacts to their bottom line.
In other economic developments, employment conditions remained strong in most jurisdictions, maintaining upward pressure on inflation, particularly in services. Residential housing market sentiment and hence prices began to reaccelerate higher on continuing tight supply, increasing immigration (Australia), and full employment with reasonable wages growth still coming through. This contrasted with leading indicators still pointing to likely recession in the period ahead, or significantly weaker conditions at the very least (ie. recession-like).
Economists and investors became ever more impatient with China’s economic woes as the country’s economic data continued to worsen with slumping household and business confidence / sentiment, very high youth unemployment, a still deflating housing market bubble, concerns that Chinese government overregulation would remain, and both foreign demand and capital flows slowing. The government continues to provide very measured and specific stimuli, prioritising volume over size, which provides incremental stability to the economy over a longer period of time rather than fixing any malaise with a big bazooka approach – a play book China has used regularly and aggressively over the last 20-30 years. This measured approach from Chinese officials has seen investors favour developed markets and other emerging markets (e.g., India, Korea, Mexico).
We almost saw another US government shutdown as the current administration’s spending continues, racking up even larger deficits and adding to the US$33 trillion debt pile. Basic economics teaches you to do the complete opposite when there is strong economic growth, and you are trying to curb runaway inflation. The current administration’s approach applies significant additional pressure on monetary policy (ie. central bank activities) and/or forces investors to react accordingly (ie. sell bonds, rising yields). Both occurred in the quarter, with rhetoric from the Federal Reserve increasingly more hawkish, putting another rate rise on the table for this year and dousing expectations of significant rate cuts in 2024.
From a market perspective, we saw both ups and downs for most asset classes given the changing dynamics discussed above. The A.I. / technology sector received considerable positive attention, with surging prices for anything tagged as being “A.I.” broadening into support for technology names.
Corporate reporting season was mixed at best, with results coming in a little better than fairly weak expectations, whilst the limited guidance provided was generally weak with rising costs and slowing demand expected in the period ahead. Those companies with very low debt levels or no debt are clearly in enviable positions.
Oil prices surged higher in the quarter as supply was further tightened by OPEC and Russia, first temporarily and then more permanently, whilst demand remained resilient. Conflicts in oil/gas rich regions also supported the price push higher as investors fretted over additional supply shortages, whilst investment in new oil/gas fields remains constrained by the global push to renewable energy sources.
There was also weakness in the AUD/USD in the period as concerns regarding the Chinese economic outlook rose (negative AUD) whilst expectations of narrower interest rate differentials between Australia and the US were dashed (positive USD) as the higher rates for longer mantra took hold.
Outlook
Given the constantly changing consensus on the path for 2024, and the stark contrast between lagging and leading economic indicators, we are taking a glass half empty type of stand – ie. it is neither a time to be fearful nor a time to be exuberant. We are also adopting a cautious and watchful approach to asset allocation, investment selection, and portfolio construction, as we await more information.
There are significant impediments for central banks to bring inflation back to target, most of which are outside of their control. That means two paths – either they continue tightening policy to force the issue sooner (economic destruction); or they maintain their roughly current tight settings and attempt to bring about a more controlled landing over a longer period of time. We think the latter path is more likely, but patience can wear thin, and inflation can have bouts of reacceleration.
We expect choppy conditions to continue until the economic path becomes clearer. We also expect economic weakness in the period ahead which means both risk and opportunity. We don’t think significant changes to portfolio settings are warranted but sensible adjustments may be necessary.
Asset Class performance – September Quarter 2023
|
Sector
|
Quarter movement
|
1-Year movement
|
CYTD movement
|
|
Australian Shares
|
-0.8%
|
13.5%
|
3.7%
|
|
Australian Shares (Small)
|
-1.9%
|
6.8%
|
-0.6%
|
|
International Shares
|
-0.4%
|
20.3%
|
15.6%
|
|
International Share hedged
|
-3.4%
|
20.8%
|
10.1%
|
|
Global Emerging Markets
|
0.1%
|
11.3%
|
7.0%
|
|
Australian Property Securities
|
-2.9%
|
12.5%
|
0.9%
|
|
Global Property Securities (unhedged)
|
-3.6%
|
2.2%
|
0.8%
|
|
Global Infrastructure (unhedged)
|
-4.9%
|
1.0%
|
-2.5%
|
|
Australian Fixed Interest
|
-0.3%
|
1.6%
|
1.2%
|
|
International Fixed Interest
|
-2.1%
|
0.5%
|
-0.1%
|
|
Cash
|
1.1%
|
3.6%
|
2.8%
|
Source: Morningstar Direct
Indices:
Australian Shares
|
S&P/ASX 200 TR AUD
|
Australian Shares (Small)
|
S&P/ASX Small Ordinaries TR AUD
|
International Shares
|
MSCI ACWI NR AUD
|
International Share hedged
|
MSCI ACWI NR USD
|
Global Emerging Markets
|
MSCI EM NR AUD
|
Australian Property Securities
|
S&P/ASX 200 A-REIT TR
|
Global Property Securities (unhedged)
|
FTSE EPRA NAREIT Global REITs TR AUD
|
Global Infrastructure (unhedged)
|
FTSE Global Core Infra 50/50 TR AUD
|
Australian Fixed Interest
|
Bloomberg AusBond Composite 0+Y TR AUD
|
International Fixed Interest
|
Bloomberg Global Aggregate TR Hedged AUD
|
Cash
|
Bloomberg AusBond Bank 0+Y TR AUD
|
As always, if you have any questions or your personal circumstances have changed please do not hesitate to contact your financial adviser
General Advice Warning - Any advice included in this article has been prepared without taking into account your objectives, financial situation or needs. Before acting on the advice, you should consider whether it’s appropriate to you, in light of your objectives, financial situation or needs.
