Economic and market overview
By Robert Wright /November 28,2022/
Pleasingly, global share markets fared well in October and recovered most of their lost ground from September. Locally, the S&P/ASX 200 Index returned 6.0%.
The sharp reversal in sentiment was typical of this year; market volatility has picked up meaningfully over the past few months, resulting in substantial swings in equity prices.
Fixed income performance was mixed. Yields drifted lower in Australia, resulting in modest positive returns from the domestic bond market. Yields continued to rise in the US, however, which resulted in negative returns from Treasuries and from global bond indices.
Investors remained focused on the persistence of inflation and, in turn, the outlook for interest rate policy in key regions.
Headline inflation quickened to an annual pace of 7.3% in the September quarter; the highest level for more than 30 years. The trimmed mean – central bank officials’ preferred measure – also increased, to 6.1% year-on-year.
The Reserve Bank of Australia continued to tighten policy settings against this background, raising official interest rates again on 1 November, by 0.25 percentage points. This could be an indication that official borrowing costs will not be raised as meaningfully as previously thought.
Official interest rates are now 2.85% and may be raised again in December. Consensus forecasts currently suggest interest rates could peak at around 3.75% in mid- 2023.
As expected, interest rates were increased by a further half percentage point, to 3.50%, as policymakers remained focused on bringing down inflation. Headline inflation quickened to an annual pace of 7.2% in the September quarter.
Substantial rate hikes in the year to date appear not to have had their desired effect, suggesting further policy tightening may be required. Forecasts currently indicate that interest rates could be 5%, or higher, by mid-2023.
The latest data showed the US economy expanded at an annual pace of 2.6% in the September quarter. This represented a sharp rebound from the June quarter, when the economy contracted slightly.
Headline inflation remained above 8% year-on-year, although the Federal Re- serve did not meet in October and interest rates were therefore unchanged over the month. That said, further policy tightening is anticipated.
The labour market remains buoyant. More than 250,000 new jobs were created in September, taking the total in the year to date to nearly four mil- lion. A low unemployment rate – currently just 3.5% – means firms are typically required to pay up to attract new employees. Wages are rising at an annual pace of 5.0%.
The European Central Bank raised interest rates by a further 0.75 percentage points, as officials continued to battle persistently high inflation. Borrowing costs have been raised to their highest level since 2009.
CPI in the Eurozone remained around 10% year-on-year, partly reflecting the impact of elevated energy prices.
Political developments continued to dominate attention in the UK. The new chancellor swiftly reversed the mini-budget that had been proposed by his predecessor. This saw the UK currency and bond market claw back their lost ground from September.
The new leaders must address a slowing economy and spiralling inflation. CPI is currently running above 10% year-on-year, resulting in sharp falls in real wages for most workers and clouding the outlook for spending.
It seems Chinese officials are likely to persevere with their ‘zero Covid’ policy, which is dampening growth prospects. President Xi tightened his grip on power during the month, by appointing various loyalists into key government positions.
The Chinese yuan remained un- der pressure, owing to the deteriorating economic outlook. The currency depreciated to a 15-year low against the US dol- lar during October.
In Brazil, left wing candidate Lula da Silva was elected as the new President; a remarkable turnaround in fortunes given the former leader was in prison for corruption three years ago. His victory was welcomed by environmentalists given his pledge to address soaring de- forestation rates in the Amazon rainforest.
The Australian dollar briefly fell below 62 US cents in mid-month, but clawed back loss- es and closed October little changed from its end-September levels (around 64 US cents).
The AUD was similarly flat against other major currencies. The dollar trade-weighted index declined just 0.3% over the month.
Australian shares added 6.0% in October, recouping most of September’s losses.
A fall in domestic bond yields supported a ‘risk-on’ attitude among investors and enabled nine out of the 11 industry sectors to generate positive returns.
The Financials (+12.2%) sector was the strongest performer, led by strong gains among the major banks. Shares in all of the ‘big four’ banks enjoyed gains of between 12% and 17%.
Oil prices rose following OPEC+’s decision to lower production quotas and after the European Union announced further sanctions against Russia. This added 9.3% over the month in the Energy sector.
Stocks in the Materials sector (-0.1%) struggled as Chinese officials reiterated their commitment to a ‘zero-Covid’ policy. Stocks in the Consumer Staples sector also struggled, resulting in the sector returning -0.2%.
Small caps outperformed their larger peers and all sectors in the S&P/ASX Small Ordinaries Index posted positive returns.
Global property securities benefited from the general improvement in sentiment to- wards equity markets, with the FTSE EPRA/ NAREIT Developed Index adding 3.6% in Australian dollar terms.
There were particularly strong inflows into western markets. France (10.1%), Australia (9.9%) and Spain (7.3%) all enjoyed strong gains, for example.
More defensive Asian property markets such as Hong Kong and Singapore fared less well, declining by 11.4% and 6.0%, respectively.
According to a recent report, inflows into global share markets picked up sharply following September’s weakness.
The influential S&P 500 Index in the US rose 8.1%, while the MSCI World Index closed the month 7.8% higher.
In the US, releases of quarterly financial results from tech gi- ants disappointed investors and meant returns from the NAS- DAQ failed to keep pace with the broader S&P 500 Index.
Asian indices performed poorly, partly due to significant weak- ness among Chinese shares. The CSI 300 fell 7.8%, while Hong Kong’s Hang Seng slumped 14.7%.
Japanese stocks fared quite well in contrast, with the Nikkei adding 6.4%.
European shares also registered solid gains. The Euro Stoxx 50 closed the month 9.0% higher.
Finally, the world’s richest per- son – Tesla founder Elon Musk – bought Twitter for US$44 billion.
Global and Australian fixed income
The federal funds rate was unchanged in October, remaining in a range between 3.0% and 3.25%.
Money markets have priced in the likelihood of a 0.75 percent- age point increase in the federal funds rate when policymakers meet in November, and an additional rate hike in December.
In October as a whole, 10-year Treasury yields rose 22 bps, closing above 4% for the first time since before the Global Financial Crisis in 2008. In fact the whole yield curve rose. These moves resulted in negative performance from the Treasury market, as well as from global fixed income indices.
Government bond yields were little changed in either Germany or Japan over the month.
In the UK, gilt yields fell back sharply from their September highs after the previous chancellor’s proposed tax cuts were abandoned by the incoming government. This resulted in favourable returns from UK bonds and helped ease pressure on pension funds in the country.
Australian Commonwealth Government Bond yields also trend- ed lower, closing the month down 13 bps.
Reserve Bank officials slowed the pace of their policy tightening, raising official interest rates by 0.25 percentage points.
Investment grade credit spreads were little changed in the month as a whole.
With spread movements providing a neutral performance contribution, returns from corporate bonds were dominated by the receipt of regular coupon income. This steady flow of income supported positive returns from the asset class.
Returns for mixed-grade credit portfolios were also boosted by much-improved performance from high yield securities. Spreads in this part of the market had widened meaningfully over the past few months; seemingly sufficiently to help attract value-oriented investors.
Source: This was prepared and issued by First Sentier Investors (Australia) IM Ltd (ABN 89 114 194 311, AFSL 289017) (FSI AIM), which forms part of First Sentier Investors, a global asset management business. First Sentier Investors is ultimately owned by Mitsubishi UFJ Financial Group, Inc (MUFG), a global financial group.