August 2023
Market update
The table below provides details of the movement in average investment returns from various asset classes for the period up to 31 July 2023.
Asset class (% change) | 1 month | 3 months | 1 year | 3 years (% pa) |
Australian shares | 2.9 | 2.0 | 11.7 | 12.0 |
Smaller companies | 3.5 | 0.2 | 0.8 | 5.9 |
International shares (unhedged) | 2.1 | 6.5 | 17.6 | 14.0 |
International shares (hedged) | 2.9 | 8.7 | 12.7 | 12.7 |
Emerging markets (unhedged) | 4.9 | 6.3 | 12.2 | 3.6 |
Property – Australian listed | 3.9 | 1.9 | -0.1 | 9.7 |
Property – global listed | 3.2 | 2.3 | -8.9 | 4.7 |
Infrastructure – global listed | 1.7 | -0.8 | -7.7 | 5.6 |
Australian fixed interest | 0.5 | -2.6 | -1.5 | -3.5 |
International fixed interest | 0.0 | -0.8 | -3.6 | -4.0 |
Australian cash | 0.4 | 1.0 | 3.1 | 1.1 |
Past performance is not a reliable indicator of future performance.
Overview & Outlook
July was another strong month for growth assets as economic data continues to point to a soft-landing scenario for the global economy. The US unemployment rate held steady at 3.6% and Australia’s unemployment rate fell to 3.5% (from 3.6%). On the inflation front, headline inflation in the US has now fallen to 3%, down from a peak of 9.1% in June 2022. Around the time that peak in inflation was occurring, an economic model maintained by the Federal Reserve Bank of New York put the odds of achieving a soft-landing scenario, whereby inflation falls without a notable loss of jobs or economic deceleration, at 10%. Today, the soft-landing scenario has become the consensus view of market participants and the driving force behind recent equity market gains.
From talk of ‘peak inflation’ in July of 2022 (and for the best part of a year before that), today the talk is more about ‘peak soft-landing’ – the notion the current outlook can’t really get any better. We have some sympathy towards this view for a few reasons. The first is the considerable disconnect between forward looking economic measures and current rate settings. This disconnect is illustrated by the following chart showing the US manufacturing PMI (a survey of business and factory managers on the state of their business and the broader economy) and the Fed Funds Rate. A reading below 50 in the PMI indicates recession, so at 46.4 the current level stands in contrast to boom time-like monetary policy settings which look set to dampen the economic outlook even further.
US ISM Manufacturing Purchasing Manager Index vs Fed Funds
Closer to home, we are concerned by a divergence in Australian home prices and would-be homeowners ‘capacity to pay’, which highlights the distorting influence of low housing supply on home prices in contrast to the fundamental state of the typical borrower.
Australian home prices versus capacity to pay
So perhaps not is all as it seems according to the soft- landing crowd?
To be clear, our view is one of caution and humility rather than outright bearishness. In the US, markets are pricing in over two percentage points in cuts to the Fed Funds Rate to June 2025, which would bolster household finances to some degree (assuming minimal job loss). It’s questionable though whether those rate cuts will be timely enough to avert a meaningful and protracted slowdown in economic activity, wrecking the soft-landing thesis.
The idea that inflation can return to most central banks ~2% target without inflicting, or being the result of, economic pain is also something of a goldilocks. Certainly if inflation were to fall apace and the jobs market remains intact, the relief and certainty that would bring to households and business could stoke a wave of credit expansion and unexpectedly strong economic growth. We’re cautious on this interpretation because if unemployment does remain at or near records lows, the risk that central banks keep cash rates higher-for-longer and sapping demand is very real. The memory of 1980’s inflation looms large in the current crop of central bank leaders.
Equities
Australian equities recorded a 2.9% total return in July and Global equities saw gains of 2.9% and 2.1% for the hedged and unhedged options respectively. Equity markets recovered from small loses earlier in the month when a stronger-than-expected US jobs report raised concerns that global interest rates would need to be higher-for-longer. The following week saw US CPI come in slightly below expectations which supported a recovery in equity markets over the remainder of the month. US second quarter earnings season got underway. As at 31 July, a little over 50% of S&P500 companies had reported with around 80% beating expectations. However, companies had set a low bar for those expectations and the broader index is on track to record a 7% fall in year-over-year earnings, according to FactSet. The earnings picture is set to improve over the coming twelve months with analysts forecasting US earnings to rise by 11%, Europe by 6% and Australian earnings by around 2%. Energy was the best performing sector locally (+8.8%) and globally (+6.1%) followed by Financials (Aus +4.9%, global +4.8%). Defensive sectors such as Healthcare, Telecoms and Consumer Staples lagged their broader index, returning between -1% and +1% locally and globally.
As previously mentioned, we have a neutral-cautious attitude where equities are concerned and reiterate the message from our July note: the concept of ‘long and variable’ lags in monetary policy looms large in our considerations. AMP Chief Economist noted recently: ‘the risk of a near term correction in share markets is high. Leading economic indicators continue to point to a high risk of recession and China’s recovery and appetite for stimulus is looking less robust than many had hoped for’. At a country and regional level, we have a preference for US and global equities over Australian and Emerging market equities, where the state of the Chinese economy (weak) and the direction of Chinese fiscal policy (unclear) lies at the heart of our views.
Fixed Income
Fixed interest markets recorded mostly flat returns in July. Australian fixed interest added 0.5% and Global fixed interest was flat.
10-year Australian and Global government bond yields edged higher in July, ending +4 and +12 basis points respectively. Yields were on track to finish unchanged until the Bank of Japan (BOJ) surprised markets by announcing a tweak to its YCC (Yield Curve Control) framework on 27 July. A quick explainer on what YCC is and why it matters:
- The BOJ is the world’s largest buyer of government bonds, owning half of all Japanese government bonds on issue and over US$1 trillion in US Treasury’s, making it the largest foreign holder of US national debt. Any sense that Japan may stop, slow, or demand a higher interest rate on government bond purchases has the potential to cause a sell-off in government bonds (i.e. yields rise).
- Yield Curve Control, or YCC,l is a form of unconventional monetary policy enacted by the BOJ in 2016. Under YCC, the BOJ promises to buy government bonds at a pre-determined level, such that interest rates and government borrowing costs are effectively capped. This cap was set to 0.5%, however the announcement on 27 July saw it rise to 1%.
- This was a surprise to some market participants because back in April, BOJ governor Ueda announced a 12 to 18 month review of the BOJ’s unconventional monetary policies and their influence on financial market and economic activity. The announcement of a tweak to YCC therefore came before that review had been completed, prompting speculation that the BOJ may step back from government bond buying sooner and/or faster than anticipated.
- Hence, government bond yields rose, and markets will now be paying close attention to what BOJ board members say, and any decisions made future BOJ meetings. The next BOJ meeting is scheduled for 22 September.
We felt it worth unpacking this development should any subsequent and related market volatility arise.
As to the more conventional forms of monetary policy, the RBA left the cash rate unchanged at 4.1% at its 4 July meeting. Towards the end of the month, the RBA’s preferred CPI measure came in at 5.9% for Q2, down from 6.6% in Q1. The decline in inflation, coupled with evidence of weakening household consumption and dwelling investment (see capacity to pay chart referenced earlier) paved the way for the RBA to keep rates on hold again at its 1 August meeting. It’s been said that ‘the next rate rise will either be in 3 months or 10 years’ as we’ve been approaching the end of this tightening cycle. Recent RBA decisions certainly point to the 10 year option and markets now expect the Fed to follow suit at its 20 September meeting. The Fed, ECB and BOE all lifted their base rates by 0.25% in July, as widely expected.
Over the medium term, fixed income is offering attractive yields relative to equities and credit, while and environment of falling inflation with some uncertainty around the growth outlook should prove supportive.
Property & Infrastructure
Australian listed property finished the month 3.9% higher with global listed property notching a 3.2% gain. Listed real assets moved in sympathy with equities in July as the rally in growth assets broadened, lifting US regional banks and the property sector where investors have been similarly concerned about the risks of higher interest rates and a slowing US and global economy. Global infrastructure posted a 1.7% gain.
Important note: While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.