Monthly Commentary: June 2024

Monthly Commentary: June 2024

Market Trends: Inflation Runs Cold

A pull back in global bond yields led to stronger returns for both growth and defensive assets in May.

The main event over the month was a relatively more benign US consumer price inflation report – after three consecutive higher-than-expected monthly results. Also market supportive was a de-escalation in military tensions between Israel and Iran, following their tit-for-tat exchange of rockets over the previous month.

With inflation still expected to decline, and central banks still expected to eventually cut interest rates, the market outlook remains encouraging – though the risk of a continued short-run equity market correction remains high.

Our hypothetical balanced portfolio rebounded by 1.0% in May, reflecting gains in both growth and defensive assets as bond yields eased. An easing in Iran-Israel tensions and a US CPI inflation report which, for the first time in months, was no worse than expected helped to support
investor sentiment.

Defensive assets rose 0.5%, reflecting modest gains in Australian and global fixed-rate bonds as bond yields fell back. Gold prices also strengthened further.

Growth assets rose 1.4%, with global equities in unhedged AUD terms returning 3.7%. The trend in global equities has been upwards since bottoming in late 2022.

The decline in bond yields supported a 1.9% rebound in the interest-rate sensitive local listed property sector, while Australian equities returned 0.9%. The trend in the relative performance of Australian equities remains downwards since early 2023. Relative returns for Australian versus global bonds have been choppy over the past year.

Global Bonds

The Bloomberg Global Aggregate Bond Index (AUD hedged) returned 0.8% in May, largely reflecting a notable retracement in US bonds yields. US 10-year bond yields declined by 0.18% to 4.50% p.a. after having gained 0.48% in April.

In turn, this reflected better news on the US inflation front, with the April CPI report in line with expectations – following upside surprises in the previous three months. There was a minor increase in US rate cut expectations over the coming year.

German and Japanese bond yields continued to rise, though remain considerably lower than in the US. The European Central Bank is still widely expected to cut rates in June, though Japan is slowly trying to extricate itself from a long-held policy of near-zero interest rates.

Credit spreads remain reasonably contained, with a modest rebound in both emerging market and high-yield corporate bond spreads in May, though within a still declining trend.

All up, the yield-to-maturity on the Bloomberg Global Aggregate Index declined by 0.08% to 3.98% p.a.

Global Equities

Lower bond yields and an easing in Middle East tensions contributed to a rebound in the MSCI All-Country World Equity Return Index of 3.7% in May on a hedged (local currency) basis, following a 2.8% decline in April.

Thanks to still bullish earnings expectations, forward earnings rose a further 1.9% in the month, while the forward-PE ratio rose 1.6% to 17.4 from 17.1.

Despite the rise in the PE ratio, the decline in bond yields allowed for a modest re-widening in equity risk premium to (a still relatively tight) 1.2%.

In unhedged AUD terms, global equities rose by 1.6%, reflecting a firmer $A over the month. On an unhedged basis, global equities have returned 20.2% over the past year.

Given the tight equity risk premium, global equities remains vulnerable to higher bond yields in the short-term. Barring the US Federal Reserve returning to a tightening bias, however, we have likely passed the peak in bond yields in this cycle.

Global Sector/Factor Trends

Strength in gold prices contributed to continued strength in global mining stocks in May, with MNRS’ index returning a further 6.3% (the same as April).

Elsewhere, the tug of war between growth and value exposures continued, with relative performance still influenced by the movement in bond yields. On the value side, global banks continued to perform well last month, with BNKS returning a further 3.9%. The decline in bond yields, however, also supported a solid rebound in the technology-heavy NASDAQ-100, with HNDQ rebounding 6.4%.

The rebound in HNDQ is indicative of the fact the easing bond yields and the “soft landing” scenario may still favour growth/technology exposures in the coming year despite their relatively lofty valuations. Despite cheaper valuations, the rotation to “value” is still far from assured.

Global Regional Trends

Along with the rebound in growth/technology, US equities performed relatively strongly in May with the S&P 500 up 5.0%.

Over the past 6-to-12 months the strongest relative performance has been in Japan (HJPN ETF) and the US (S&P 500). America’s performance is related to the ongoing strength in growth/technology exposures, whereas Japan’s performance can be attributed to relative cheapness, a weak Yen, and solid corporate earnings as more companies focus on improved shareholder returns.

Australian and UK relative performance, however, remain in a downtrend, while Europe is broadly tracking global returns.

Australian Cash and Bonds

The Bloomberg Australian Bond Composite Index returned 0.4% in May, in line with broadly flat local bond yields. Cash returns, according to the Bloomberg Bank Bill Index, lifted another 0.4%.

There was little change in the market’s RBA rate outlook over the past month, with local long-term bond yields holding steady despite the decline in US yields. This likely reflected recent higher than expected inflation results and a continued neutral to mild tightening bias from the RBA.

Indeed, fixed-rate bonds have experienced choppy sideways performance against cash since the peak in bond yields in October last year.

Corporate credit spreads, meanwhile, continue to narrow, which is supportive of corporate bond outperformance over government bonds.

Australian Equities

The S&P/ASX 200 Return Index rose 0.9% in May after a 2.9% decline in April. The market ended the month still above the trading range it was stuck in for the previous few years.

Forward earnings declined by 0.7% in the month, reflecting downgrades to expected earnings growth. Forward earnings are down 5.4% over the past year, and it’s the weakness in earnings that largely accounts for the underperformance of the Australian market versus global peers.

At 16.4, the forward PE ratio is at the top end of its range over recent decades (apart from the COVID period spike).

Given positive expected earnings growth in FY’25, forward earnings should rise over the coming year – but at this stage not as much as expected by the global market. The recent downtrend in earnings expectations – due to sluggish economic growth and delayed rate cut expectations – is also concerning.

Australian Equity Themes

Within the Australian sharemarket, technology (ATEC), financials (QFN) and quality (AQLT) have delivered relatively strong performance over the past year, whereas small caps (SMLL) and resources (QRE) have tended to underperform.

Eventual RBA rate cuts should favour a strengthening in credit growth and hence the performance of financials, while the small but vibrant technology sector would also benefit from an eventual lowering in bond yields.

The tilts away from resources and towards technology are also favouring companies that screen highly by the quality factor (i.e. companies with relatively high return on equity without excess leverage) though the superior earnings performance of these companies across a range of sectors appears to be mainly responsible for AQLT’s ongoing outperformance.

This article was originally produced by David Bassanese from BetaShares. You can read the full article here.

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