Global share markets shrugged off banking sector concerns and posted strong gains in the March quarter.
Banks & property were the weakest sectors, which led to under performance from the Australian market.
Bond yields declined in response to the banking sector concerns and signs that inflation had passed its peak.
International Equities
Headlines in March were dominated by the failures of the Silicon Valley Bank (SVB) and Signature Bank in the United States, and the forced merger of Credit Suisse with UBS in Europe following concerns over the ongoing viability of Credit Suisse. Sentiment did improve by the end of the month, though, as swift action by regulators in both jurisdictions calmed markets. In addition, a prevailing view that the events were not caused by any widespread systematic or structural issue appeared to dominant market consensus.
The United States was the largest contributor to the positive global equity result last quarter, with the S&P 500 Index rallying 7.5%. Showing particular strength were the large US Information Technology stocks, some of which posted gains above 30%. Lower bond yields provided a source of support for the more “growth” orientated sectors. Investors were also attracted to companies with strong internal cash flow generation as they would be less likely to be impacted by any tightening in credit being made available by financial institutions. Gains outside of the U.S. were less impressive, but still material, with the Japanese market posting a strong 6.7% increase.
Emerging markets were also positive with the MSCI Emerging Market Index rising 5.3% over the quarter. Although losing some momentum in the second half of the quarter, China’s reopening from its extended lockdown made a positive contribution. China’s 4.4% rally last quarter followed strong gains in the months of November and December last year.
Global listed property was sold off heavily in February and March but still managed to post a small gain of 0.1% for the quarter. On an annual basis, returns are now negative 21.3%, making it by far the worst performer across the major asset classes. Falls in listed property in March were related to the banking sector, with concerns that a tightening of bank credit supply could impact on property prices. In contrast, global infrastructure continued to perform well, rising 3.2% over the quarter.
Australian Equities
Although still producing positive returns, the Australian share market underperformed global averages last quarter, with a 3.5% increase in the S&P ASX 200 Index. Energy and financial stocks were the two weakest sectors. Falling oil, coal and natural gas prices from 2022 peaks weighed on the energy sector. However, energy stocks remain 14.7% ahead on annual basis.
A 2.7% decline in the financial sector brought its annual result down to negative 5.4%. Initially, the fall in banking stocks was triggered by CBA’s earnings guidance highlighting lower than expectedfuture growth in interest margins. Bank stocks then weakened further in response to the financial difficulties experienced by SVB and Credit Suisse. Although there are no concerns over the prudential position of Australian banks, the tightening of global credit conditions could raise funding costs for banks more broadly. As was the case globally, listed property also reacted negatively to the global banking issues, with the Australian sector sold off in the final month of the quarter. This restricted the gains in listed property to 0.3%.
Fixed Interest & Currencies
After falling in January and rising in February, bond yields fell again during March due to concerns over the health of the banking sector. With credit conditions expected to tighten, the market took a view that the need for tighter monetary policy was lessened. In addition, expectations around the timing of future cash rate reductions were brought forward. For the quarter as a whole, the fall in longer term bond yields was significant, creating positive returns for investors. The U.S. 10-year Treasury bond yield dropped 0.36% to 3.52%. The fall in Australian yields was even larger, with expectations that RBA would soon pause its tightening program prompting a 0.75% decline in the 10-year government bond yield to 3.30%. Cash interest rates around the globe continued to move higher though in March. Most notably the U.S. Federal Reserve stayed on course despite the banking sector issues and lifted its cash rate benchmark by a further 0.25% to a high of 5.0% in March. However, in early April the Australian Reserve Bank announced that the cash rate would be held at 3.60%, the first pause in rates for 11 months.
After reaching a peak of U.S. 71.5 cents in early February, the $A drifted lower over the remainder of the quarter due to softer commodity prices and a widening interest rate differential i.e. interest rates lower in Australia than overseas). Against the $US, the $A dropped from U.S. 67.8 cents to U.S. 67.1 cents over the quarter. Falls against the Euro and Yen were also recorded, with declines of 2.9% and 1.0% respectively.
Outlook and Portfolio Positioning
The response of bond and equity markets to the issues that emerged in both the U.S. and European banking sector in March was inconsistent. For bond markets, the issues were deemed to be highly significant, prompting a change in the course of expected monetary policy decisions and material change in the level of bond yields. The bond market response was based on the premise that banks will now have to restrict loan availability in order to shore up their capital positions. As a result, financial conditions would become more restrictive, and this tighter availability of credit would reduce the need for central banks to keep interest rates as high as they were otherwise planning to do.
Although equity markets did sell-off at the time the news of the banking issues was unfolding, the sell-off was short lived and major markets finished higher over March.
Implicit in this response from equity markets is a view that any change in financial conditions resulting from recent events will have little impact on the general level of spending and company profitability. If bond markets shared this view, then yields would not have fallen so significantly during March.
The one area of consensus across markets does appear to be the view that the issues experienced by Credit Suisse, Silicon Valley Bank and Signature Bank were largely unique to those institutions. No doubt other banks will come under scrutiny. However, unlike the GFC, corporate and loan defaults are generally still quite benign, with the broader banking sector very well capitalised. Household balance sheets are also generally strong, underpinned by ongoing strength in labour markets across the globe.
None-the-less, the fact that the recent difficulties faced by specific banks is not symptomatic of a wider crisis does not mean that these events won’t change general financial market and economic conditions. Bank funding costs are likely to be higher as a result and their lending practices more conservative and restrictive. General liquidity on financial markets, including credit markets, may be lower. This combined with more fragile investor sentiment could result in magnified responses by financial markets to periods of negative news.
Hence, as is often the case, the correct interpretation of the banking issues just experienced probably lies somewhere between the bond market and equity market response. The magnitude of decline in bond yields may have been an overreaction, which makes longer term bonds now less attractive. Cash, or cash like investments, therefore, remain as the preferred defensive investment, with cash yields now materially above those at the longer end of the yield curve.
Conversely, equity markets may have been a little too optimistic in pushing prices higher late in March, ignoring the potential for further fallout from additional bank failures and more restrictive financial conditions. Longer term, it could be argued that the case for holding benchmark equity exposure remains sound. There is no widespread financial market dysfunction and the outlook for medium term company earnings remains solid. Shorter term though, it may be a more difficult environment, with the implications of higher interest rates and more restrictive credit availability yet to be fully absorbed into the real economy and company earnings.
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.