– July Market Snapshot –
- Favourable inflation data, both global and local, saw bond yields shift lower.
- Increased confidence that the US Federal Reserve would cut cash interest rates supported smaller and cyclical stocks, at the expense of larger technology stocks.
- Interest rate sensitive assets, such as property and infrastructure, also benefited from the improved interest rate outlook.
International Equities
In a significant turnaround from the dominant trend of the past two years, it was smaller companies and cyclical stocks that led global equities higher over July. Underpinning this rotation in market leadership was a rise in confidence that the U.S. Federal Reserve would lower interest rates in September. This confidence was attributable to softer inflation and economic growth data in the United States. A lower interest rate environment was seen as being more supportive of cyclical and smaller companies. Overall, global equities averaged a positive return of 1.2% last month, with global smaller companies rallying 9.5%.
European markets performed slightly better than the United States over July, with the U.S. negatively impacted by a significant rotation of support away from the technology sector. Large technology stocks in the U.S. declined by an average of 1.7%, with the overall S&P 500 Index rising in value by 1.2%. Japan moved against the broader trend, with the Nikkei Index falling 1.2%. Japanese equities were negatively impacted late in the month by the Bank of Japan’s decisions to raise cash interest rates to approximately 0.25%. Although still low in absolute terms, this is the highest cash rate in Japan for more than 15 years. Japan’s central bank also indicated that they would be winding back their purchase of longer-term bonds, which resulted in a jump in both bond yields and the Yen exchange rate – both of which were seen to be negative for listed companies in Japan.
The emerging market index continued to be held back by China, where the equity market was flat last month. However, another strong month in India (up 4.4%) enabled the MSCI Emerging Market Index ($A unhedged) to finish 2.6% higher.
Lower bond yields were particularly beneficial to real assets, with global listed property (up 5.5%) and global listed infrastructure (up 4.4%) both rising strongly. The Australian listed property sector also performed well, with a 6.8% gain coming despite a relatively small increase in Goodman Group (by far its largest constituent) of 1.0%.
Australian Equities
The Australian share market outperformed the global average last month, with the S&P ASX 200 Index rising by 4.2%. This outperformance came despite ongoing weakness in resource and energy stocks, which were negatively impacted by a flat iron ore price and lower oil price.
Banking stocks continued to be well supported, with the finance sector advancing by 6.3%. Perhaps more surprising was the consumer discretionary sector, which rallied 9.1%. Consumer discretionary stocks are now 29.5% higher for the year, which belies the generally weak state of consumer spending across the wider economy. Wesfarmers and JB Hi-Fi were two key contributors in July, with gains of 13.0% and 13.8%, respectively. The Australian market did benefit in relative terms from having a small technology sector, which was sold down globally and posted just a minor gain of 0.2% locally last month.
Fixed Interest & Currencies
Bond markets drew renewed confidence from inflation data released over July, which was seen as being supportive of looser monetary policy. Data in the U.S. continued to suggest a steady tracking downwards towards the long-term inflation target. In Australia, although the June quarter data indicated a rise in the annual rate from 3.6% to 3.8%, the result was slightly better than expected.
The United States 10-year Treasury bond yield fell from 4.36% to 4.09%. A similar shift occurred in Australia, with the 10-year yield falling 0.23% to 4.12%. Longer term yields in both countries are at similar levels, despite the cash interest rate in the U.S. currently being approximately 1% higher. This is perhaps indicative of the money market’s confidence that lower U.S. inflation will support larger cash rate reductions there.
With bond yields in the U.S. falling, there was less support for the $US, which depreciated against the Euro and Yen over July. However, the $A was also weaker and fell against the $US from U.S. 66.2 cents to U.S. 64.9 cents. The $A’s decline against the Euro and Yen was more significant, with respective depreciations of 3.2% and 6.9%. This was a reversal of the trend from each of the previous 4 months when the $A had strengthened against both the Yen and Euro.
Outlook and Portfolio Positioning
The rotation that took place on equity markets over the month of July was overdue and helped rectify a disparity in valuations between the technology sector and large parts of the remainder of the market – especially smaller companies. Although the catalyst for the rotation was a fall in bond yields, the change in market leadership was also an acknowledgment that there was little fundamental justification for technology stocks to rally further in the absence of any further upward revision to earnings expectations.
Whilst global share markets finished the month of July in perhaps a more logical place in terms of valuation mix, this position was short lived with a significant correction taking place in the first week of August. Global share markets fell by 6.6% in the first 3 trading days of August, before stabilising and gaining back approximately half that reduction in the next 4 days. Although much of the reported cause of this early August sell-off was put down to an increased risk of recession in the United States, there was little in the way of fundamental economic data to support such an immediate change in the assessment of the economic outlook.
It is more likely that technical market factors were the predominant driver of the August correction. More specifically, the Bank of Japan’s announcement of an increase in the overnight cash interest rate (to approximately 0.25%), and its intention to be less supportive in buying government bonds, appeared to have a significant impact on equity markets. Higher borrowing costs for Japanese investors is likely to have triggered a selling of equities by these investors. This helps explain why the Japanese share market fared the worst of all markets, falling by 21% in the first 3 days of August and then recovering by 10%.
Given the apparent technical nature of the August equity market correction, and the relatively quick partial recovery in valuations, there are few obvious implications for long term portfolio positioning. For investors looking to enter the equity market or top up existing holding, it perhaps represents a short-term opportunity where valuations are slightly more attractive than they were one fortnight earlier. Additionally, the further decline in longer term bond yields that took place in August following the falls recorded in July have reduced the attractiveness of longer-term interest rate durations relative to cash rates. Cash rates appear destined in Australia to remain at their current level for at least several months ahead.
The August correction does, however, serve as a reminder of the sometimes volatile and fickle nature of financial markets. With increased uncertainty now in place over the outcome of the U.S. election, and major global geopolitical issues remaining unresolved, the period ahead could be challenging for investor sentiment. Such a period may require a greater focus on long term strategies and market fundamentals to avoid the temptation to be swayed by shorter term noise and momentum.
Important Information
The following indexes are used to report asset class performance: ASX S&P 200 Index, MSCI World Index ex Australia net AUD TR, MSCI World ex Australia NR Hdg AUD, 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), CSI China Securities 300 TR in CN, Deutsche Borse DAX 30 Performance TR in EU. Hang Seng TR in HKD, MSCI United Kingdom TR in GBP, Nikkei 225 in JPY, S&P 500 TR in USD.
General Advice Disclaimer
Any advice contained in this document is of a general nature only and does not take in to account the objectives, financial situation or needs of any particular person. Any decision to invest in products mentioned in this document should only be made after reviewing the relevant Product Disclosure Statements. Past performance is not a reliable indicator of future performance. Varria Pty Ltd is an authorised representative of Charter Financial Planning ABN 35 002 976 294 AFSL number 234665