Market Data July 2023
July was a relatively strong month across the board for markets with almost all asset classes having made gains. Leading the way was emerging market equities, returning +4.9% thanks to strong gains in the ex-China region, especially Eastern Europe and Latin America. The other side of that coin is that Chinese market returns have been relatively lacklustre, although the market has been highly polarised, and the large tech or EV companies that Western firms tend to be exposed to have been doing well. During the month Xi Jinping made it clear that the crackdown on these firms is over and is now appealing to overseas investors in his bid to rejuvenate the flagging economy.
Economic data across the world came in looking weak in July, however it wasn’t quite as dire as had been expected and as a result, markets mostly took them in stride. Overall, consumers (particularly in the US) have been resilient, while inflation pressures appear to be receding, and wage inflation remains relatively constrained. The Fed raised rates one more time by0.25%, very much as expected, and Jerome Powell managed to say nothing that would upset markets about their future intentions. On the face of it, it could hint to the immaculate disinflation and soft landing that markets have been hoping for.
Meanwhile in Australia, trends may look worse, with retail faltering, especially given July’s weak retail sales number that put the market on the back foot. Australia’s inflation print for July surprised on the downside, which was good that the market liked, but perhaps related to weak sales. This may be a reminder to be careful what we wish for, highlighting that this soft landing is a narrow path to stay on, and a lot can go awry be twixt and between.
Turning to the bond markets, the investors remain highly focused on the near-term intentions of central banks (and the US Fed in particular) as well as longer term rates which declined over the month. One issue that may be slipping beneath the radar is that slowing inflation combined with cautious, determined central banks might actually mean higher real rates and, effectively, unintentionally tight monetary policy.
Market Returns - 1 Month to 31 July 2023 (in AUD)
The ASX 200 rose by 2.9% in July, supported by the belief that central banks are now close to the end of the interest rate tightening cycle thus avoiding a hard landing for the global economy.
With interest rates at a two-decade high there was warranted concern that a broad- based contraction was inevitable. We believed that the cumulative effect of multiple rate rises would have had a deleterious impact on the economy and equity market valuations.
Our proposition was that in an environment where interest rates moved from virtually zero to be up over 400 basis points in 14 months, corporate balance sheets and earnings would be strained.
As such we prepared the portfolio to have more defensive characteristics, to be overweight in Consumer Staples, Healthcare, and the Telecommunication sectors.
Instead, what has transpired has been a more benign outcome where the economy has remained resilient, supported by strong employment and high migration levels. At the same time inflation has peaked and now is in an orderly decline, suggesting that monetary policy could achieve a goldilocks (soft) landing for the economy.
Under this backdrop, cyclical Industrials and Information Technology companies have been strong out performers relative to Quality and Defensive companies. Moreover, the July bounce in the ASX 200 has now pushed valuations above average, with the price earnings ratio trading on >15 times for the 12 months to December 2023.
Nevertheless, we remain cautious heading into the upcoming FY23 earnings season. Recent company announcements and an increase in negative earnings revisions suggests Australian companies have begun to experience a slowdown, as higher interest rates and cost of living pressures weigh on the consumer.
We expect a moderate downturn in corporate profits, with bottom-up expectations for the ASX 200 EPS forecasting a low single digit contraction for the 12 months to December 2023.
At a portfolio level, Industrials, Banks, and Energy sectors led by Cleanaway Waste Management, National Australia Bank, and Woodside Energy were strong performing stocks. Notably, the major banks (+6.6%)outperformed the broader equity market (+2.9%) following the RBA’s decision to hold the cash rate steady.
Whereas CSL, Woolworths, and Northern Star weighed negatively on performance. Overall, the Healthcare sector was the weakest sector for the second month in a row, weighed down by CSL (-3.2%) where the pace of recovery post-COVID is slower than expected. While the Healthcare sector has lagged materially over the last 6 months, we do expect a strong recovery in earnings over FY24-25.
In an environment where corporate profits are expected to slow, we remain defensively positioned in the key sectors of defensive industrials (consumer staples, telecommunications) and Healthcare, which should offer greater earnings resilience.
July was wild intra-month for bonds as yields spiked to start with on the back of stronger than expected CPI data globally, then dipped by an even greater reaction following weakness in other economic releases. The Australian 2-year yield finished the month 28 basis points tighter at 3.94% following aggressive widening of 118bps over May and June. Despite strength in the 2y, the 10y yield pushed 4bps wider over July to close the month at 4.06%, continuing the selling trend since a yield of 3.30% at the end of March 2023, however at a lesser pace. Although there was a lack of calm in markets, the AusBond Composite (BACM0) Index rose 0.52% for the month, and the Bloomberg Global Aggregate (LEGATRUU) Index returned 0.69%. A slightly positive month for duration saw the AusBond Composite Index outperform the AusBond Credit FRN (BAFRN0) Index for the first time since April 2023, which returned +0.46%.
Strength in credit markets was present in the high beta regulatory capital (AT1 and Tier 2) sphere. BondAdviser’s AUD AT1 and AUD Tier 2 Indices saw continued trading margin compression over July. Both markets saw significant rallies, with the Tier 2 Index tightening by 21bps over the month to 183bps, while the AT1 Index finished 37 basis points lower at 233bps. These moves drove total returns of +1.21% and +1.25% for T2 and AT1, respectively. The Prime Australian Defensive Income Portfolio benefitted from such exposures along with robust credit markets, returning 72 basis points, not just outperforming the Bloomberg Bank Bill Index by 35bps, but providing excess returns over its basket of comparable indices.
July was a rosy month across the board as all of the Prime Australian Defensive Income Portfolio’s holdings drove a positive return. The best performers on a HPR basis were the AT1 holdings as WBCPJ, CBAPM, and CBAPL respectively appreciated by +1.68%, +1.51%, and +1.35%. Although MQGPF was more muted (+0.39% HPR), the total weighted portfolio contribution from AT1 holdings was +13bps. The best performing individual securities on a weighted return basis were the Metrics Direct Income Fund (for the third straight month) adding +12bps to the weighted result (+0.95% HPR), and SUBD which added +11bps from a +1.11% HPR. The weakest holding was the PIMCO Global Bond Fund with a HPR of +0.03%.
The Langdon Global Smaller Companies Fund, which was only recently added to the portfolio at the beginning of July, was the best performer for the month (when only counting the days it was in the portfolio), thanks to strong gains made in global small caps in general and a bit of alpha made on top from the fund’s security selection.
Following up second in return was the Trinetra Emerging Markets Growth Trust. Pleasingly, these two funds topping the chart hints to under-loved pockets of the market now benefitting from the ‘margin of safety’ afforded by the combination of cheap valuations and strong growth prospects in an eventual recovery.
One area of the market which is not following that playbook so much is Japan where the market is not enjoying the prospect of the central bank relaxing their grip on long term bond rates (yield curve control). However, although the Japan market finished the month slightly in the red, the Platinum Japan Fund in the portfolio managed to outperform and gain +2.1%. Although such a short timeframe of performance shouldn’t be used as evidence to a successful investment thesis, this does bolster the promise of their strategy to pick certain Japanese companies who are better suited to leverage their balance sheet if Japan’s regime change continues and rates aren’t kept extremely low forever.
The MFS Concentrated Global Equity Trust and Aoris International Fund were the only 2 managers to suffer losses in July and drag down performance. This was a result of their “quality” bias turning out of favour as inflation prints came in lower, decreasing investors rate expectations, and accordingly, switching to the “growthier” end of the market.
Growth of $10,000 (Income reinvested) vs MSCI World Gross Total Return AUD Index
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