Recent rallies on both bond and equity markets were partially reversed over December.
Central bank guidance continues to point to further rate rises ahead.
Chinese equities recovered stronly late in the quarter, despite a significant rise in COVID infections.
International Equities
Despite a pull-back in December, global share markets finished the quarter well into positive territory after an extended negative run. Investors took confidence from signs that a weakening global economy and a gradual repair of supply chains may be reducing inflationary pressure. This was highlighted by Consumer Price Index data in the United States, that showed annual inflation dropping from 8.2% to 7.1% between September and November. Given the possibility that US inflation has peaked, there may now be less upward pressure on interest rates, which is positive news for the value of global bonds and equities. It increases the possibility of a “soft landing”, in which any economic downturn may be briefer and less severe than may have been expected previously. This more positive outlook contributed to a 2.0% increase in the U.S. S&P 500 Index last quarter.
The two-month rally on global equity markets was brought to an end in December with major developed markets finishing the calendar year on a negative note. Despite further evidence of a softening in inflationary pressure, the U.S. led global markets lower, with the S&P 500 Index declining 6.9% over the month of December. An underperformance from the Information Technology (IT) sector was one factor causing the U.S. market to perform below other major markets where IT is less significant. Losses in Europe, the UK and Japan were more moderate, being in the range of -1.0% to -2.0% for December.
The reversal in trend from the rally of the previous two months appeared to be related to the guidance from central banks. Commentary was consistent from the European, U.S. and Australian central banks indicating that further interest rate increases are likely, as the slowdown in spending is yet to be sufficient to return inflation to the target ranges. The European Central Bank provided the most explicit direction following their December decision to raise cash rates by 0.5%, with President Lagarde suggesting that “anybody who thinks that this is a pivot for the ECB is wrong…we should expect to raise interest rates at a 50bps pace for a period of time.”
European share markets were particularly strong over the quarter. Notwithstanding an acute “cold snap” across much of the Northern Hemisphere, the winter in Europe has generally been milder than expected, which has lowered energy prices and eased concerns around supply constraints. Germany was a key beneficiary of the brighter sentiment, with the DAX Index jumping 18.7%.
It was, however, another positive December month for the Chinese and Hong Kong equity markets, both higher by between 2% and 3%. Investor sentiment continued to be buoyed by the relaxation of China’s extended COVID related lockdown policies. Sentiment remained solid despite the evidence that COVID infection rates were reaching extreme levels. Gains on the Chinese market, however, were insufficient to push emerging markets overall into positive territory, with the MSCI Emerging Market Index falling by 2.0% for December. Declines in India (down 4.0%) and South Korea (down 9.1%) were significant, with weakness in some commodity prices weighing on Latin American markets.
Higher bond yields and poorer general market sentiment also led to losses in the property and infrastructure asset classes last month. As interest rates have continued to increase, the
attractiveness of yields from these sectors has progressively declined on a relative basis.
Australian Equities
The Australian share market outperformed global averages over the quarter, with the S&P ASX 200 Index rising by 9.4%. Resources made a major contribution to this, buoyed by the optimism around the reponing of China and associated strengthening in the iron ore price.
A 19% surge in the iron ore price failed to lift the Australian market over December, with the S&P ASX 200 Index falling by 3.2% for the month. However, due to the optimism around the reopening of China and the stronger iron ore price, resources was one of the better performed sectors (down 1.2%). Energy stocks, though, experienced larger losses, with falling global oil and energy prices weighing on the sector. Notwithstanding an acute “cold snap” across much of the Northern Hemisphere, the winter in Europe has generally been milder than expected, which has lowered energy prices.
Interest rate sensitive stocks took some comfort from the lowering of bond yields mid quarter, with Property Trusts, Financials and Utilities posting strong gains. The 28% bounce in the Utilities sector was heavily impacted by a 41% jump in the price of Origin Energy, which received a takeover offer from Brookfield Asset Management. Movements in the more defensive sectors were less impressive, with Consumer Staples (up 1.8%) and Healthcare (up 1.9%) the weakest performers.
Expectations that higher interest rates will ultimately reduce spending continued to lower earnings expectations for the consumer discretionary sector, which recorded the largest loss for the Decemeber month, with a decline of 7.0%. For the year as a whole, the consumer discretionary sector fell 20.4% - significantly underperforming the broader market decline of just 1.1%.
Fixed Interest & Currencies
Although bond yields declined following evidence of weaker global inflation during the quarter, they rose again in December after commentary from central banks reinforced the expectation of further cash interest rate increases. For the 3-months as a whole, U.S. 10-year Treasury Bond yields were 0.05% higher at 3.88%. The increase in Australia’s 10-year Government bond yield was slightly more significant, rising from 3.90% to 4.05%. The larger increase in Australian yields came despite the Reserve Bank putting in place a more moderate rate of increase in the cash interest rate, which rose by 0.25% in October, November, and December to close the quarter at 3.10%.
Possibly due to the sign of bond yields peaking in the U.S., the $US weakened over the December quarter, allowing the $A to appreciate. Against the $US, the $A rose U.S. 2.7 cents to U.S. 67.8 cents. However, the $A was weaker against the Euro and the Japanese Yen by approximately 4%. The Yen was heavily supported following the Bank of Japan’s decision to raise the cap on its 10-year government bond yield from 0.25% to 0.50% in December. The move was viewed by investors as the first sign of policy tightening by the Japanese central bank.
Important Information
The following indexes are used to report asset classperformance: ASX S&P 200 Index, MSCI World Index ex Australia net AUD TR composite of 50% hedged and 50% unhedged), FTSE EPRA/NAREIT Developed REITs Index Net TRI AUD Hedged, Bloomberg AusBond Composite 0 Yr Index, Barclays Global Aggregate ($A Hedged), Bloomberg AusBond Bank Bill Index, S&P ASX 300 A-REIT (Sector) TR Index AUD, S&P Global Infrastructure NR Index (AUD Hedged).
General Advice Disclaimer
This document has been prepared by Sage Advisers Pty Ltd (AFSL 238039). Any advice provided is of a general nature and does not take into account personal circumstances. Any decision to invest in products mentioned in this document should only be made after reviewing the relevant Product Disclosure Statements. Should the reader wish to avail of using the above investment philosophy they should only do so firstly seeking personal financial advice thourgh a financial adviser. Past Performance is not a reliable indicator of future performance.