Market Data July 2024
Market Returns - 1 Month to 31 July 2024 (in AUD)
Market Commentary
A month on from reporting season, July 2024 marked a volatile period in global markets, characterised by shifting monetary policies and evolving economic indicators. In Australia, persistent inflation concerns fuelled speculation about further rate hikes, while the US economy showed resilience with a 2.8% growth in Q2. Political uncertainties, including the upcoming US presidential election, continued to impact market sentiment.
The Australian market rallied in the last week of July, with defensive sectors outperforming while Energy declined. Large caps outperformed, reflecting a risk-off sentiment among investors.
US markets experienced a leadership shift, with the tech-heavy Nasdaq showing weakness after earlier surges. Small-cap stocks and sectors like real estate and industrials benefited from lower rate expectations, while mega-cap tech stocks, including the "Magnificent Seven," faced challenges despite beating earnings expectations. European markets, particularly Germany, displayed economic weakness with contracting PMIs and deteriorating business sentiment.
In the bond market, Australian composite bonds dipped 0.11%, while global aggregate bonds declined 0.81% hedged. Global high yield bonds underperformed. The Federal Reserve was expected to hold rates steady but signal a potential September cut, while the Bank of Canada's rate cut sparked speculation about other central banks following suit.
Economic data suggested easing inflation but a slowing economy. The US consumer price index came in slightly below expectations at 3% year-over-year. In the last week of July, developed market equities outside Australia rose 1.43% in AUD terms but were slightly negative when hedged.
Emerging market stocks were flat, while Japan's Nikkei 225 and European stocks declined. The divergence in performance between markets and company sizes provided opportunities for active management.
Australian Equities
The ASX 200 rose 4.2% in July, setting a new high for the equity market index. The uplift in equity prices was primarily supported by a more benign inflation report in Australia and expectations that the US Federal Reserve would begin to cut interest rates in September. This fuelled a sharp rise in cyclically exposed industries, with Discretionary Retail (+12.2%), Banks (+7.1%), and Real Estate (+6.6%) leading the gains. Notably, it was the Australian banks that made the biggest contribution to share markets return, given its large weight in the ASX benchmark of ~22%. From the market lows in October 2023, the Banks have accounted for 40% of the benchmark return. The strong performance of the Banks has pushed their valuations to record levels with the 1 year forward Price Earnings (P/E) multiples trading at ~18 times. The major banks returns have been supported by a more resilient economy, disciplined lending standards, and strong regulatory capital positions providing scope for share-buybacks. Nevertheless, we believe the re-rating of banks is now well overdone as current valuations are well ahead of long-term averages and the outlook for earnings growth is uninspiring.
In marked contrast, the Resources sector’s underperformance has been stark as commodity prices have weakened on the strength of the US dollar and as the backdrop for the Chinese economy remains challenged, impacted by ongoing headwinds of a property sector battling oversupply and financial de-leveraging.
At a portfolio level, James Hardie (JHX), ResMed (RMD), and CSL were notable strong performers. Whereas, Origin Energy (ORG), WiseTech (WTC), and Ramsay Health Care (RHC) weighed on performance.
Price momentum rather than profit momentum has pushed the ASX 200 to record levels in July. The re-rating of the ASX 200, driven primarily by the Banks, has pushed the market P/E to a 1-year forward P/E of 17 times, well ahead of its long-term average of ~14 times. Overall earnings growth for the ASX 200 looks insipid with a decline ~4% forecast for the upcoming FY24 reporting period. With growing evidence that valuations were elevated and economic activity showing more consistent signs of slowing, in June 2024 we reduced the portfolio’s exposure to more economically sensitive sectors, and increased the weighting to defensive stocks, particularly utilities. As we opined in our last monthly update, we believe a more cautious stance on equity markets is warranted as we face into heightened period of earnings uncertainty at a time when interest rates remain elevated (notably in Australia), and government debt is burdensomely high.
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Defensive Income
The past couple of weeks have seen massive overreactions to weak data prints and central bank actions. We are waiting for the dust to settle, but think much, although not all to be reversed here. It is clear that the markets have moved from a risk-on to a risk-off sentiment. And we think that is something that sticks with us for at least the next quarter if not longer.
July began with the US 10-year yield at 4.40% and it is now at 3.88% (7-Jun-24). Yields have fallen, and the curve has steepened as the probability of recession has jumped, seeing bonds trade well in the flight to safety trade. It all began with weaker results in tech company earnings releases in late July, followed by a dastardly poor US PMI print on Thursday 1 August and then the extremely weak US jobs read spurred on the capitulation. While this was going on the Fed correctly held the cash rate target at 5.25-5.50% on Wednesday 31 July. What was underreported and most seismic of all, was the Bank of Japan increasing rates to 0.25%. This was in the face of a still weak Japanese economy, and surprised many traders, causing a run on highly leveraged carry trades that were funding in Yen.
Markets are now calling for 50bps of Fed cuts at the September meeting (no August meeting planned) and a total of eight 25bp cuts in the next 12 months. Some market participants were even banging the table for an emergency rate cut decision to stem the bleeding as global markets suffered (Nikkei 225 down 12% on 5-Aug). Locally there was also a flare of market overreaction to a slightly better than expected CPI print on 31 July that saw the 2-year tighten 22bps on the day.
Since the last day of June 2024, the Global Aggregate Bond Index (LEGATRUU) is up +4.95%, having risen 2.76% for July. The AusBond Composite Index (BACMO) returned +1.48% for July while the AusBond Credit FRN Index gained 0.52%.
July was also a strong month for local financial capital as AT1 and Tier 2 spreads both tightened meaningfully. The BondAdviser All AUD AT1 Index returned 1.18% for the month, closely followed by our All AUD Tier 2 Index, up 1.07% in July. The Prime Australian Defensive Income Portfolio returned 1.04% for July, its 14th consecutive positive month, producing 6.83% over the past year versus the Bloomberg Bank Bill Index's 4.36%.
All of the portfolio's holdings were in the green in July with PIMCO Global Bond Fund leading the charge on the back of duration outperformance, producing a HPR of 1.69% and a weighted 21bp contribution. Also materially positive were the Yarra Higher Income Fund (+14bps) and the Pendal Government Bond Fund (+11bps). Capital gains of +73 basis points led the way for the month, supplementing the robust and predictable income produced by the portfolio. There were no transactions over the month.
International Equities
The Langdon Global Smaller Companies Fund was the top contributor, returning 9.5% and outpacing the benchmark. This performance highlights the resurgence of small-cap stocks amid expectations of a softer economic landing. The Nanuk New World Fund (+6.2%) and Aoris International Fund (+4.9%) also delivered strong returns. Their focus on companies with robust balance sheets and high-quality business models proved particularly advantageous this month, as investors sought stability amidst economic uncertainties and shifting market dynamics.
Conversely, the portfolio's largest position, the iShares S&P 500 ETF, returned only 1.6%, as the United States underperformed the broader market. This underperformance was driven by disappointing tech earnings and concerns over potential restrictions on semiconductor exports to China.
The Munro Concentrated Global Growth Fund (-0.7%) and GQG Partners Global Equity Fund (-0.7%) struggled, reflecting the challenges faced by growth-oriented strategies in a market grappling with mixed economic signals and shifting sector preferences. The portfolio's diversified approach helped balance returns across various sectors and investment styles. The Pzena Global Focused Value Fund (+5.1%) performed well, showcasing the benefits of the portfolio's exposure to value strategies.
Overall, the underperformance in July was a result of exposure to the underperforming U.S. market, coupled with the challenges faced by growth-oriented funds in the current economic environment. Despite strong performances from small-cap and value-oriented strategies, these were not sufficient to offset the drag from the larger U.S. equity positions.
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