September Quarter in Review
BELOW IS A SUMMARY AND HIGHLIGHTS FROM THE MOVEMENTS THIS QUARTER AND MAJOR CHANGES TO SOME OF THE KEY ASSET AREAS:
The Australian equity market (as measured by the S&P/ASX 200) nine-month positive run came to end with a (-1.85%) return for the month of September however the quarter ended up in positive territory albeit soft, returning (+1.71%). The quarter was consumed with continuous lockdowns as the Delta strain took hold of a number of parts of the country, global growth concern, inflation fears as well as the inclusion of the all-important August corporate reporting period. The 2022 financial year got off to a good start as July and August recorded a solid aggregate return of (+3.6%) however as volatility increased and the sound of inflation beating louder, the quarter petered out with concerns of global supply - especially within energy - slowing China growth and questions of a continuing global recovery keeping markets on edge.
Reporting season was generally positive despite increased volatility with broader focus surrounding re-opening trades. The market looked through poor results from companies most affected by Covid and looked importantly onto the next 12-18 months. Quality growth and Cyclicals performed strongly however companies were very hesitant to provide earnings guides due to at the time, lockdown uncertainty. Most sectors however are expected to deliver positive earnings growth in FY2022.
As a result of increased risks to the downside and uncertainty, sector returns became quite muted as the quarter drew to an end. The Energy sector (+16.7%) for the month, (+9.3%) for the quarter, benefitted greatly from the global power shortage, as spiralling prices coupled with pandemic-induced supply-chain crunch continue to push the sector to higher levels. Most sectors in September, although giving back some returns obtained so far throughout the year, held up quite well in the quarter as a result of a solid reporting season and optimistic outlook. Industrials (+6.6%), Utilities (+5.1%), Communications Services (+5.1%), Financials (+4.9%) and Information Technology (+4.7%) all providing solid returns. The Materials sector (-9.9%) was the biggest laggard as volatile and unpredictable commodities markets resulted in oil, gas and coal prices soaring over the quarter as supply concerns became more apparent. Performance across the market cap spectrum (company size) broadly followed the same path, however Mid-caps (+3.7%) continued to slightly outperform large caps (+1.7%) and small-cap (+3.4%).
Global equity markets experienced the same drawbacks as the domestic market. Negative sentiment due to increased fears surrounding inflation, fears of contagion from the financial woes of giant Chinese developer Evergrande, general slowing of China growth and regulatory reform, debate about lifting the US debt ceiling to avoid government shutdowns plus soaring energy prices all weighed on investor sentiment resulting in the September sell-off. Despite the weakness in September, the US market (S&P 500) returned another solid quarter (+4.4%) whilst broader global equity markets (MSCI World NR AUD) also held up well returning (+3.9%); Emerging Markets (MSCI EM Index AUD) unfortunately felt the full force of all things China as a changing regulatory regime and concerns over a defaulting Evergrande kept Chinese equity markets under pressure. Although pockets of EM performed well, mainly within EMEA - Russia and Saudi Arabia were up on rising energy prices - the broader market fell (-5.5%). Geopolitical uncertainty and continuing concerns over potential monetary policy tightening remain potential headwinds; Europe (STOXX Europe 600 index) returned (+2.4%) whilst the Asian markets (MSCI AC Asia Ex Japan) recorded a disappointing (-5.8%) driven largely by the significant sell-off in China.
Property & Infrastructure
The Australian listed property sector (S&P/ASX 200 A-REIT) performed well in the quarter producing a return of (+4.2%) although earnings revisions during reporting season did produce some mixed results. The reopening trades seem to be almost fully priced in although performance divergence across sub-sectors still remains as repercussions of the pandemic and government responses is still being primarily felt in the hotel, office, and retail sectors. Performance across niche sectors such healthcare, childcare, self-storage, and logistics continue to demonstrate resilience.
Global listed property (unhedged) returned (+3.8%), underperformed the domestic market as the fall- out of Evergrande hurt international indices (rightly or wrongly) coupled with some (not surprising) pull-back in performance as the sector has run very strong over the past 12-18 months.
Global listed infrastructure (unhedged) returned a solid (+3.9%), dominating currency hedged returns (+1.0%) helped by a depreciating Australian dollar. Both sectors continue to provide solid returns - off the back of improving fundamentals and economic conditions - and continued diversification benefits. Although some pull-back was expected due to the impressive run of both sectors, particularly REITS, over the last 12 months, returns, as noted last quarter, should continue to be supported by vaccine rollouts and the continuing reopening of global economies and infrastructure-led fiscal stimulus packages.
Bonds and Cash
Central banks globally, including the RBA continue to remain accommodative in support of bond markets although fears of an overshoot in inflation is gathering momentum. Yields on 10-year treasuries, both domestically and globally were extremely volatile throughout the quarter, however ended the quarter quite flat.
The 10-year Australian Treasury yield increased from 1.471% to 1.488% whilst the 10-year US Treasury yield also increased slightly from 1.469% to 1.487%. These rises, albeit minimal, along with slightly higher, broader increases in major Euro sovereigns, coupled with tapering bond purchasing agendas from the US Fed, has brought inflation expectations and hence inflation fears forward. Whether it be transitory or potentially longer lasting than expected, bond and equity markets will be affected at varying levels. For the quarter, Australian bonds (Bloomberg AusBond Govn 0+Yr) returned (+0.33%) whilst global bonds (BBgBarc Global Aggregate TR Hedged) returned a miserly (+0.05%). Investment grade corporate bonds (particularly Europe, as economic activity stokes pent-up demand), and higher yielding bond assets remain well supported with cooperative monetary policy in place and the hunt for yield. Cash yields remained untouched as the RBA left the official rate at 0.10% throughout the quarter.
Quarter in review
The September quarter was definitely a tale of two-halves, with the stronger first half outweighing the weaker second half.
The strong first half came off the back of rising covid delta variant concerns which resulted in a significant reduction in inflation concerns and increased belief that the US central bank would need to delay any policy tightening plans as increased restrictions would once again see demand wain and the economic growth trajectory would soften. That resulted in market rotation back to Covid winners (ie. growth over value or more cyclically exposed) stocks. This rotation was strong and swift, and markets were off to the races again, supported by continued significant policy stimulus from both governments and central banks, with the taps still running.
We then had a confluence of risks in the second half of the quarter that investors tried to take in their stride but by September had gotten all too much for them. These risks included: both US fiscal and monetary policy paths, with fiscal side focused on potentially too much stimulus and potential breach of their self-imposed debt ceiling, whilst the monetary side focused on the central bank’s tightening path; rising inflation concerns yet again as inflation remained stubbornly high for another quarter with supply bottlenecks getting worse and rising energy prices not helping; rising China concerns regarding weakening levels of economic growth, Evergrande and broader property market issues, and energy shortages hitting home especially on the manufacturing / industrial output front; and lastly, but not least, concerns regarding a broader energy crisis given shortages reported throughout Europe and Asia together with US oil inventories running very low.
Individually, each of these concerns would not be enough to derail investor sentiment in light of the significant amount of liquidity in the system, which is continuing to be provided by both governments and central banks at near emergency levels. However, with each of these concerns getting worse as the quarter went on, investors decided to take some risk of the table which resulted in all asset classes giving back some to all the quarter’s earlier strong returns. Portfolio construction also wasn’t helped in the quarter with government bond yields rising strongly (ie. prices falling) on the back of rising inflationary concerns which may result in the US central bank acting earlier, and potentially faster, to tighten their policy path.
At the quarter’s end, there was some lightening of concerns with paths emerging as a way out from some of these risks and investor sentiment appeared to be troughing or bottoming out. However, these risks have not been resolved and will likely still feature in the December quarter.
Given the concerns raised above, investor sentiment is likely to remain mixed in the coming quarter as officials, regulators, policy makers, and the private sector try to resolve some or all of these issues. What is somewhat divisive is whether the extraordinary government and central bank stimulus is still helping to resolve these issues or is in fact causing them. What is clear is that whilst virus concerns remain, and lockdown / restriction of movement remains a policy response, governments and central banks can’t afford to step away from policy stimulus just yet.
We think the pace of reopening is likely to continue in the period ahead which will help with the economic trajectory. The primary question then is can policy makers effectively thread the needle on the timing and the quantum of reduction in their current stimulus policy path. Too quick (or large) a reduction will not be taken well by investors, but to slow (or small) a reduction may result in unproductive excesses building up which also won’t be taken well. We think they can, but it will take a measured and well telegraphed response along with plenty of boldness and flexibility.