March Quarter 2024

Key points

• Equity All-Time Highs: Global and Australian equities have continued to rise in Q1 2024, with many major equity markets reaching all-time highs.

• Bond Split: Australian bonds gained, and global bonds fell as markets reacted to economic data and central bank comments.

• US Dollar Regains Ground: The US Dollar gained over the quarter while the Australian Dollar fell as expectations for US rate cuts were pushed back.

• Cautious 2024 Outlook: Expect market volatility with a focus on diversified equities and medium-duration bonds.

• Sector Performance: Technology outshone the rest of the market globally and even in Australia despite a lack of strong domestic investment options in the sector.

1.      Markets in Review

Entering 2024, investors exhibited caution as they waited to see the effects of aggressive rate hikes on the wider economy. Thus far, investors have been encouraged by the resilience of the global economy and subsequently all major equity markets finished positive for the quarter with many reaching all-time highs. The best-performing region was the Eurozone which benefitted from investors de-concentrating their portfolios away from the US where valuations continue to be stretched, especially in comparison to Europe which is currently trading at a discount. Despite this, the US still performed well over the quarter returning 10.2%, even with inflation not slowing as expected.

Fixed Income had a mixed month as we start to see divergence in different economies and sectors. The 10-year U.S. Treasury yield concluded the quarter at 4.2%, up by 32 basis points since the start of the year. This was a result of stronger than expected growth and stickier inflation leading fixed income investors to re-think rate cut predictions.

2.      Returns

Throughout the first quarter of 2024 the S&P/ASX 200 returned around 4%, this pace being much slower than what we saw near the end of 2023 as strong economic data has pushed expectations for rate cuts back towards the end of the year. The strongest performing sector was Technology, returning 24.2%, as fervour surrounding the A.I. boom picked up speed. Despite this massive rate of return the sector’s performance had little effect on the overall S&P/ASX 200’s performance due to the Technology sector making up just 2.86% of the index. Real Estate also continued to perform well due to the expectation that we are at peak interest rates and approaching the first rate cuts.

The only sector that meaningfully retracted over the quarter was Materials (-7.8%) which can largely be attributed to a reduction in the price of iron ore. An interesting scenario has arisen around gold miners, whose share prices have failed to keep up with the rise in the price of gold itself. This divergence likely stems from an increase in production costs due to higher labour costs.

3.      Foreign Exchange Markets

In contrast to the last quarter of 2023 the USD dollar index (DXY) against a basket of currencies strengthened by 3.2% over the first quarter of 2024. This occurring due to strong economic data out of the US and comments from the Federal Reserve leading investors to push back their expectations of rate cuts in the first half of 2024. As rate cuts are expected later, bond yields remain elevated, attracting investors to the USD and increasing its relative value. This has led to a depreciation of the Australian dollar against the USD of 4.4% from 0.68 to 0.65.

The currency that depreciated the most against the USD was the Japanese Yen (JPY), depreciating by 6.9%. A prolonged period of negative interest rates in Japan has had the effect of reducing the currency’s desirability amongst traders in our current environment of high interest rates in most developed countries. In Q4 the Bank of Japan finally acted and increased interest rates for the first time in 17 years from -0.1% to 0-0.1% in an attempt to stimulate the economy.

4.      Fixed Income Markets

It was a volatile quarter for fixed income as strong economic data and central bank comments fought investor expectations for rate cuts, but in the end Australian bonds ended up by just 0.57% while global bonds ended down by 1.16%. Australian bonds gained over the quarter due to the belief that central bank rates have reached their peak, and that the RBA is simply waiting on the data to reflect inflation returning to the 2-3% target band before they begin to cut rates. The US reached the same position late last year, but the data has continued to suggest that inflation is not yet under control, meaning rates must remain elevated, leading to a decline in the price of bonds.

The US continues to have a yield curve inversion, the longest by far in the last 40 years. The inversion which was previously shrinking has slightly expanded again as the expected date of the first Federal Reserve rate cut continues to be delayed. A yield curve inversion is a common recession indicator in the US with every inversion in the past forty years being followed by a recession. With the latest inversion being longer than most that came before investors are waiting to see whether the indicator remains true.

The Australian yield curve has normalised for quite some time now, but we are still waiting to see whether Australia will enter a recession or narrowly avoid one as inflation slows.

5.      Outlook

Our outlook for the rest of 2024 remains much the same as it was at the start of the year. We initially predicted in January 2024 that most of the expectations for rate cuts around halfway through the year were far too optimistic, which has proved to be the case as many outlets have pushed their predictions back. We continue to predict that inflation will become stickier the closer we come to the RBA’s 2-3% target band, which has been clear to us in the strength of the labour market and the general economy during this first quarter of the year. Our belief is that given the RBA lagged the other central banks with lifting interest rates (in particular the US), they will also lag other central banks on the way down.

Regarding equities, we continue to expect volatility as rate cuts fail to arrive for most of the year. This does not mean that equities cannot perform well between data releases and central bank meetings, but we believe there will be greater volatility. In order to allocate your portfolio effectively in light of this prediction we continue to suggest a well-diversified equity portfolio, allowing access to any broad market rallies while limiting exposure to rate-sensitive sectors that may exhibit more of the aforementioned volatility.

It is a time for some slight caution in fixed income as central banks watch inflation data closely to determine their next course of action, so we suggest a medium-duration approach to fixed-income investing. While it seems unlikely at the moment that central banks will raise interest rates once more, if the data suggests that inflation is resurging then they will have little other choice. It is due to this slight chance that we suggest a slight overweight to duration. This approach should prove beneficial in a scenario of interest rate cuts while also providing a healthy income in the more likely scenario that rates remain at their current level for a longer period of time before they are eventually lowered.

 

By Peter Kelly 

In today's world, it is crucial to plan for the future and make provisions for unforeseen circumstances.

One way to ensure our interests and well-being are protected is by appointing an enduring power of attorney (EPA).

An EPA grants someone we trust the legal authority to make decisions on our behalf when we are no longer capable. This powerful legal instrument offers numerous benefits that can provide peace of mind and safeguard our interests. Let's explore some of the key advantages of appointing an enduring power of attorney.

Protection During Incapacity

Life is unpredictable, and there may come a time when we are unable to make decisions for ourselves due to illness, disability, or mental incapacitation.

By appointing an EPA, we can ensure that a trusted individual, known as the attorney, will step in to make decisions in our best interests. This includes managing our financial affairs, paying bills, accessing bank accounts, and handling property matters.

The EPA acts as a safety net, guaranteeing that our interests are protected even when we are unable to voice our wishes.

Choice and Control

By appointing an EPA, we retain control over who will make decisions on our behalf if the need arises.

We have the freedom to choose a person we trust implicitly, someone who understands our values, preferences, and wishes. This ensures that our voice continues to be heard, and our best interests are upheld.

Without an EPA, decisions about our well-being may be made by someone appointed by a State-based civil and administrative tribunal, which may not align with our desires.

Seamless Financial Management

Appointing an EPA streamlines the financial management process during incapacitation.

Our attorney can handle financial transactions, pay bills, manage investments, and ensure our financial affairs remain in order.

This eliminates the need for lengthy processes, such as guardianship, which may otherwise be required to grant someone the legal authority to act on our behalf.

Reduction of Family Conflicts

In situations where there is no appointed EPA, family members may have differing opinions about who should make decisions on behalf of an incapacitated individual. This can lead to conflicts, causing emotional stress and strained relationships.

Appointing an EPA in advance minimises the potential for such conflicts by clearly designating the person who will make decisions, eliminating ambiguity and promoting family harmony during challenging times.

Preservation of Dignity and Autonomy

An EPA ensures that our dignity and autonomy are upheld even when we are unable to make decisions independently.

By appointing someone we trust as our attorney, we can rest assured that our values and preferences will guide the decision-making process.

This helps preserve our identity and ensures that our wishes are respected, even in situations where we cannot communicate them directly.

Conclusion

Appointing an enduring power of attorney is a prudent step to protect our interests, maintain control over our lives, and alleviate potential burdens on loved ones during times of incapacity.

It provides peace of mind, promotes family harmony, and safeguards our dignity and autonomy.

By choosing a trusted individual to act on our behalf, we ensure that our best interests are prioritised, and our wishes are respected.

Embracing the benefits of an EPA empowers us to navigate the future with confidence, knowing that our affairs are in capable hands.

By Peter Kelly on 20 September 2023

At the end of March 2023, there was a massive $3.5 trillion held by everyday Australians in superannuation.

That is $3,500,000,000,000.

For any government with ambitious spending plans, this could be an attractive pool of money to target.

In a previous blog, “What is the purpose of superannuation?” I mentioned one idea being circulated that would see superannuation potentially being used to fund the cost of providing aged care.

The word being used in this context was “ring-fencing”.

The concept of ring-fencing could see a situation arise where a portion of one’s superannuation savings are set aside to cover potential (future) aged care costs. If this was ever introduced, it would mean a person would only have access to a portion of their superannuation savings to fund their general retirement living expenses. Part of their savings would need to be quarantined to fund future aged care needs.

But let’s not get too far ahead of ourselves. I think this is a long way off and is unlikely to be a politically palatable pill for any present or potential government to swallow.

The legislation to enshrine an objective in superannuation is currently open for consultation. It appears to be innocuous in its current form.

As mentioned in a previous post, the objective of superannuation is proposed to be:

“To preserve savings to deliver income for a dignified retirement, alongside government support, in an equitable and sustainable way.”

The explanatory materials accompanying the draft legislation include the following paragraph (paragraph 1.8):

“The superannuation system is an important source of capital in the economy which can support investment in capacity-building areas of the economy where there is alignment between the best financial interests of members and national economic priorities.”

While the statement addresses the “best financial interests of members” (of superannuation funds), this is balanced with “national economic priorities”.

Does this mean that superannuation could be targeted as a source of investment in specific areas, including housing, infrastructure, technology, community, and the like?

Put simply, could a government mandate our superannuation be invested in areas other than those we might voluntarily choose to participate in?

This raises an interesting academic question and one that I am sure will be pondered by experts for many months and years to come. Incidentally, for those who might suggest the government would never dictate how our superannuation should be invested, here is a quick history lesson.

In 1961, the “30/20 rule” was introduced. Superannuation funds were required to invest at least 30% of their assets in public securities, with 20% being invested in Commonwealth-issued securities (e.g. Government bonds), if the funds were to receive concessional tax treatment.

The 30/20 rule was eventually abolished in 1984.

While the 30/20 rule was a “soft compulsion” – that is, superannuation funds received tax concessions in return for compliance – it is an example of how governments may implement policy to achieve outcomes consistent with their policy objectives.  

With superannuation now comprising of such a large component of the economy, it will continue to remain the focus of all potential governments, irrespective of their political persuasion.

Local and global stock markets rose this week on the back of weaker economic data.

Australian employment unexpectedly fell in April with 4,300 fewer people employed versus March. The fall saw the unemployment rate tick up to 3.7% with an additional 18,400 unemployed.

The minutes of the RBA’s May meeting show that the decision to raise by 0.25% was a close one, but concerns surrounding strong services inflation pushed the call over the line.

Eurozone industrial production fell by 4.1% in March, coming in well below expectations and the biggest fall since April 2020. The largest contractions came from Ireland and Germany.

The European Union raised its inflation forecasts to 5.8% this year and members expect the European central bank to continue with rate hikes.

Japan’s economy emerged from recession and grew faster than expected in the first quarter as post-covid consumption rebounded strongly.

US President Biden cancelled his trip to Australia for the Quad meeting and shortened his G7 trip to Asia to focus on resolving the US debt ceiling debacle which remains ongoing. Estimates have the US government running out of money to meet expenses as early as 1 June.

Top of Mind: Debt Ceiling in Focus

The latest concern and risk that investors are having to contend with is the prospect of the United States defaulting on trillions of dollars’ worth of loans. That is unless the Republicans and Democrats strike a deal to legally allow the US Department of Treasury borrow more though debt to allow it to pay its bills.

The amount of debt that the US can incur is known as the debt ceiling and the “X date” is the date at which the US will hit that limit. While the exact date for the “X date” is hard to predict, Treasury Secretary Janet Yellen has indicated the government will fall short of funds by mid-June. 

Thankfully over the weekend, debt ceiling talks that had stalled were back on with Joe Biden and Kevin McCarthy agreeing to resume negotiations to avoid the US defaulting. This came a day after they broke off talks! 

If Democrats and Republicans do not agree to allow the US to raise the debt ceiling - the world's biggest economy will default on its $31.4 trillion (£25tn) debt. If the US does not lift its debt ceiling, it will not be able to borrow more money - and it will quickly run out of funds to pay for public benefits and other obligations.

The White House Council of Economic Advisers estimates that if the government cannot reach a debt ceiling agreement for a prolonged period, the economy could shrink by as much as 6.1% which would most likely tip the US into the recession that it is heading towards. That would have big knock-on effects for the rest of the world, many of which count the US as a key trading partner.

In addition, the US dollar is the reserve currency of the world. Should the US government default, the value of the dollar is expected to drop sharply with knock on effects for commodities and commodity orientated economies such as Australia.

It could also exacerbate the inflationary problems we have already been facing. With a weakening US dollar, everything would need to be repriced. That could lead to food and fuel becoming more expensive and would again raise the cost of living for millions of people.

The stock market is also likely to react badly to a US default as it erodes confidence in the world’s largest developed market economy. We don’t think that will be the case though. If history is a guide, you would expect a resolution to be met. Although, it wouldn’t be surprising to see it left to the last minute and create a lot of volatility across markets. That is what we saw in 2011 when the Democrats and Republicans remained at an impasse over the debt ceiling until hours before a potential default. US stock markets plunged but it was short-lived, and shares recovered from the sharp fall once details of the deal became known. We think we are likely to see the same again this time round.

Local and global equity markets were mixed this week with contrasting signals across economic data including falling US inflation, a UK rate rise, and weakness out of China.

Westpac shares rose after the bank lifted its dividend by 15% and announced a first half net profit increase of 22% to $4 billion. Commonwealth Bank shares rose following its quarterly result with the bank reporting a net profit increase of 1% to $2.6 billion but said that net interest income was 2% lower in the quarter.

The Federal Budget surprised with a $4.2 billion surplus, a significant improvement from the last estimate of a $36.9 billion deficit, with stronger than expected revenue from mining, corporate and income taxes. The government showed some fiscal restraint, but no plans to fix likely budget deficits in the years to come.

Australian new house lending rose by 4.9% in March, the first increase since January 2022, with lending to owner occupiers rising by 5.5% and to investors by 3.7%. Lending to first home buyers rose by 12.3%. The rise for the month was a big shock and may put further pressure on the RBA to maintain tighter monetary conditions.

Australian building approvals in the first quarter were the weakest in 11 years whilst business conditions fell in April. Australian retail trade volumes fell by 0.6% in the March quarter. Outside of the covid period, this was the largest quarterly fall in volumes since the GFC. Cost of living pressures along with higher interest rates finally hitting home.

US consumer prices rose at a 4.9% annual pace in April, slowing slightly from March and coming in below expectations. The annual core figure, which excludes food and energy, rose 5.5% in April down from 5.6% in March

German industrial production fell more than expected in March which saw recession fears escalate in Europe’s largest economy. Production decreased by 3.4% on the previous month partly due to weak performance by the automotive sector.

The Bank of England hiked rates by 0.25% to 4.5% at its May meeting, bringing interest rates to their highest level since 2008. The lift was widely expected.

China’s consumer inflation slowed to the weakest pace in two years in April while producer prices fall deeper into deflation. Stimulus likely to be required but authorities playing the waiting game for now.

US Treasury Secretary Janet Yellen said there are no good options for solving the debt ceiling stalemate and cautioned that resorting to the 14th Amendment would cause a constitutional crisis. There is a deal to be had, but President Biden is holding Congress hostage by not being amenable to any future budgetary cuts. US deficits are out of control and getting larger.

The Reserve Bank of Australia (RBA) Board has increased the cash rate by 0.25% to 3.85% at its May meeting. 

The move was a fairly big surprise for markets given the largely consensus call for another month of pause. Whilst the March quarter inflation print was pleasingly lower, confirming a lower trajectory ahead, the mix of underlying components showing some “stickiness” effectively forced the RBA’s hand to push monetary settings further into contractionary territory to ensure the inflation trajectory continues lower. 

There were some key changes to their May statement relative to the prior month. 

Key points of focus include: 

• A tone of impatience creeping into the statement – ie. inflation is still too high; it will be some time yet before it is back in target range; importance of returning inflation to target within a “reasonable timeframe”. 
• Reiterated their inflation forecasts of 4.5% for 2023 and 3% for mid-2025. • Happy with goods price inflation falling but unhappy with services price inflation, particularly the combination of rising labour costs without any productivity increases. 
• Reiterated their economic growth forecasts of 1.25% for 2023 and around 2% over the year to mid-2025, with unemployment set to increase to 4.5% in mid-2025. 
• Confirmed their commitment to return inflation to target but again emphasised “in a reasonable timeframe”. 

We still believe that the RBA is near the end of this hiking cycle given the lagged effect of the cumulative rate increases since May 2022, but they will need to see continued evidence of headline and particularly underlying inflation falling over the coming quarters, and/or a subsequent pick-up in productivity growth. 

Following their announcement, Australian equities moved lower, the AUD/USD rose, and bond prices fell (ie. yields higher).

Local and global equity markets were mixed to slightly weaker for the week as investors digested key economic data and US banking sector stress. 

US banks came under pressure again after First Republic, a San Francisco bank, reported a poor set of quarterly results, with investors again questioning the regulator / central bank’s resolve. 

The US economy is proving resilient, but we continue to expect rapid monetary tightening to trigger a recession later this year. Our models still point to elevated recession risk, and a recession beginning later this year remains our base case. Stresses in the banking sector mean that credit conditions are likely to continue to tighten, consistent with the Fed killing the cycle. 

Internationally, central banks continue to be the focus with the US Fed and ECB both expected to hike rates. In the US we are likely to see a 25bps hike which is almost fully priced in now by the market. Powell’s comments will be closely scrutinised to see if further hikes are on the table or if they pivot towards the market which is expecting the Fed to begin cutting through the latter part of this year. Over in Europe, the ECB meets with markets torn between 25 vs. 50bp, although we think 25bps more likely.

Australian headline inflation rose by 1.4% in the quarter which saw the annual rate fall to 7%. The RBA’s preferred measure of underlying inflation increased by 1.2% in the quarter with the annual rate falling to 6.6%. Goods inflation falling sharply, services inflation going the wrong way. Good to see it lower overall, but plenty of work still to be done.