Monthly Commentary by Blackmore Capital (Australian Equities Consultant)
The ASX 200 declined 2.5% in May as Banks and Resources, the bell-weather sectors of the Australian equity market, weighed heavily on market returns. The 1H23 bank earnings results highlighted the near-term outlook remains challenging. The initial benefits of higher interest rates on bank net interest margins (NIMs) have been diluted by elevated competition for deposit and mortgage customers. A more cautious outlook for earnings and returns for the banks has further contributed to its relative underperformance.
While the sell-off in resource stocks reflects rising recessionary concerns in the West and a weaker than expected economic recovery in China. The initial enthusiasm for a recovery in commodity prices from China’s re-opening out of the pandemic has been dampened in the short-term by disappointing domestic manufacturing and employment data suggesting a more sluggish economy. The energy sector has also not been immune to recessionary concerns over a weaker outlook for global industrial production.
In sharp contrast, optimism towards the technology sector’s improving growth outlook and futuristic benefits of Artificial Intelligence (AI) underpinned the outperformance of growth stocks relative to value stocks over the month.
At a portfolio level, Industrial and Healthcare sectors led by Cleanaway Waste Management, CSL, and Integral Diagnostics were notable strong performing stocks. Whereas BHP, Ramsay Health Care, and Amcor weighed negatively on performance.
Undoubtedly, there has been a material divergence in performance within the Healthcare sector. CSL’s share price outperformance over the last year ~+15% relative to the ASX 200 ~+1% has been underpinned by a robust recovery in its plasma therapies division. CSL’s plasma collection volumes are up ~30% year-on-year, providing a welcome uplift in operating margins. With initiatives to further improve productivity and operating leverage, CSL remains well placed to deliver double digit earnings growth over the forecast period.
Ramsay’s 3Q23 update highlighted a more challenging operating environment. While there has been a solid recovery in elective surgical admissions in Australia and the UK, ongoing cost headwinds relating to labour availability and wage inflation, have impacted operating margins. Over the medium term we believe Ramsay should be a beneficiary of a continued recovery in surgical volumes and momentum returning in its non-surgical categories driven by ageing demographics and chronic disease.
The recent US and Australian reporting periods have highlighted that corporate earnings remain relatively resilient despite the impact of rising interest rates. Earnings growth is expected to slow over the remainder of calendar 2023, but still record low single digit eps growth. The ASX 200 is trading on a 12-month-forward price earnings ratio (PER) of ~14.5 times, and dividend yield of ~4.3% (around their 30-year average). While the ASX 200 is neither ‘cheap’ nor ‘expensive’ on historical metrics, we continue to be mindful that the backdrop for global economy suggests a further slowing in activity. Our portfolio remains positioned in the key sectors of defensive Industrials, Healthcare, and Materials, all of which continue to offer favourable long-term prospects.
Monthly Commentary by BondAdviser (Fixed Income and Credit Investments Consultant)
May was volatile with skittish duration fears, however these were eventually put to rest as bonds found some late strength. Over the ten trading days from 12 May to 26 May, the AusBond Composite (BACM0) and Bloomberg
Global Aggregate (LEGATRUU) Indices fell -1.93% and -3.10%, respectively. Over this time, the MOVE Index spiked back up to 145 from 120. The month-on-month returns for BACR0 and LEGATRUU were -1.21% and -1.95%.
This weakness drove a similar narrative to April in that credit again outperformed duration with the AusBond Credit FRN Index (BAFRN0) returning +0.34%. This BAFRN0 result reflects slight tightening in credit spreads but also the carry benefits of a 3mBBSW at ~4%. Trading margins on BondAdviser’s AUD AT1 and AUD Tier 2 indices both widened over the month, but the weakness in Tier 2 paled in comparison to the selling across AT1 markets.
The AT1 Index saw trading margins widen +50bps to 308bps while the Tier 2 Index widened +7bps to close the month at 216bps. Amongst all of this volatility, the Prime Australian Defensive Income Portfolio returned a negative 3 basis points, with our credit carry offsetting some losses on the duration book. However, it did underperform the Bloomberg Bank Bill Index by 32bps.
The Metrics Direct Income Fund was once again in the top performers, contributing +10bps to the weighted result (+0.76% HPR). The next best performers were the MA Priority Income Fund (+0.64% HPR) and SUBD (+0.50% HPR), contributing +8 and +5 basis points, respectively. The largest detractors were the Yarra Australian Bond Fund (-1.30% HPR), the PIMCO Global Bond Fund (-0.64% HPR) and the three active AT1 exposures (between -0.44% and -1.07% HPR).
The combination of these five positions drove a -26bps detraction from the month’s returns. Pleasingly, the sale of the Alceon Debt Income Fund has completed and the portfolio took exposure to CBAPM on 13 June.
Monthly Commentary by Mercer
Developments In The Global Economy
In May, risk asset returns in developed markets were mostly negative, bonds and real assets also generally declined. Emerging market equities returns were marginally positive.
News flow during May focused predominantly on the debt ceiling deadline looming in early June. Overall, the market impact has been fairly limited, although ratings agencies have placed US credit on watch for potential downgrades.The challenges facing regional banks in the US continued to be a major topic in early-May with regulators brokering a deal for JP Morgan to purchase First Republic Bank. However, the sell-off in shares of other vulnerable banks continued along with sizable deposit outflows.
Economic data in general remained resilient. US unemployment rose slightly in May but remains at historically low levels, although, other indicators such as wage growth show that the labour market is gradually cooling. Forward-looking purchasing manager indices remain in expansion territory across most major regions, with strength in services outweighing weakness in manufacturing. In spite of economic resilience, headline inflation continued to decline in most major economies, falling to just under 5% in the US. Inflation in Japan rose to 3.5%, which is high by historical standards, but still lower than in other developed countries. In the UK and Eurozone, inflation remains more resilient, but also on a downward trajectory. Inflation in China remains low amid a slow and developing expected economic recovery.
Rate markets continue to grapple with the question of how long monetary policy will remain tight. The bond market is pricing in an initial rate cut toward the end of this year or early next year, but US Fed officials have generally cast doubt on that timeline. Credit spreads moved slightly higher during the month. Issuance is coming back after a slowdown earlier in the year when the first signs of distress emerged among US regional banks.
Over May, Hedged Developed Markets Overseas Shares returned -0.2%, equity volatility increased moderately over the month, with one spike early in the month due to renewed banking concerns and another spike later in the month amid debt ceiling negotiations. Earnings season for Q1 2023 is coming to an end, with a second consecutive quarterly decline. Equities markets have seen through weaker earnings so far as attested by strong year to date returns for Overseas Shares. Over the month, it was notable that growth outperformed value by a large margin, in spite of rising yields. A couple of contributors included optimism over developments in A.I. favouring growth stocks, while more cyclical sectors that dominate value indices lagged. Emerging Markets Shares (UH) gained 0.4%, as poor performance in China offset positive performance in other major emerging economies.
Hedged Overseas Government Bonds returned -0.6% over the month as bond yields generally increased during May. In the US, the 10-year bond yield rose by 14bps, while the 30-year yield was up by 18bps. In developed markets outside the US, 10-year yields rose by 5bps for Japan and 46bps for the UK, while falling 3bps for the Eurozone. US inflation expectations, as measured by the 10-year inflation breakeven rate, fell 3bps to 2.2%.
Australian Shares returned -2.5%, underperforming their overseas counterparts in May. IT (10.4%) and Utilities (1.1%) were the strongest sectors, meanwhile Consumer Discretionary (-6.2%), and Consumer Staples (-4.5%) were the largest detractors.
- Australian seasonally adjusted employment decreased by 4,300 in April, below expectations for an increase of 25,000 and above the prior month’s decrease of 53,000. The unemployment rate increased to 3.7%, above expectations of 3.5%. The participation rate remained at 66.7%, in line with expectations. Part time jobs increased by 22,800 and full time jobs decreased by 27,100.
- Australian building approvals decreased by 8.1% month-on-month to April, compared to the decrease of 1.0% (revised) for March.
- The Institute for Supply Management (ISM) Manufacturing Index recorded 46.9 in May, below consensus for 47.0 and below the 47.1 recorded in April. Of the four manufacturing industries that reported growth in May, the top performers were Non-metallic Mineral Products and Furniture & Related Products. There were 14 industries that recorded contraction in May compared to April.
- The ISM Services Index recorded 50.3 in May, below consensus for 52.4 and below the 51.9 recorded in April. Of the 11 services industries that reported growth, the top performers were Accommodation & Food Services and Management of Companies & Support Services. There were seven industries that reported a decrease in the month of May.
- US Non-Farm Payrolls increased by 339,000 in May, above the 253,000 increase recorded for April. The unemployment rate increased to 3.7% over May, above expectations of 3.5%.
- US GDP second estimate for Q1 2023 is 1.3% quarter on quarter (QoQ) annualised, above expectations of 1.1%.
- The Caixin Manufacturing PMI in China recorded 50.9 in May, above expectations of 49.5, as manufacturing output growth improves to 11-month high.
- The preliminary estimate of the European Core CPI recorded 5.3% over the year to May, below expectations of 5.5%.
- The Eurozone composite PMI increased to 52.8 in May, below expectations for 53.3.
- The first estimate recorded for Q1 2023 Eurozone seasonally adjusted GDP is 0.1% QoQ and 1.3% YoY.
The Australian share market underperformed its hedged overseas counterpart over the month as the S&P/ASX300 Index returned -2.5%. The S&P/ASX Mid 50 Accumulation Index was the strongest relative performer, generating a flat return, while the S&P/ ASX Small Ords was the weakest, returning -3.3% over the month.
The best performing sectors were IT (10.4%) and Utilities (1.1%), while the weakest performing sectors were Consumer Discretionary (-6.2%) and Consumer Staples (-4.5%). The largest positive stock contributors to the index return were CSL, Woodside Energy and Xero with absolute returns of 2.0%, 2.8% and 17.8%, respectively. In contrast, the most significant detractors were NAB, BHP and Westpac with absolute returns of -9.5%, -4.6% and -7.5%, respectively.
The broad MSCI World ex Australia Accumulation Index returned -0.2% in hedged terms and 1.2% in unhedged terms over the month as the AUD depreciated against the USD and GBP. In AUD terms, the strongest performing sectors were IT (10.5%) and Communication Services (5.8%), while Energy (-8.4%) and Materials (-5.2%) were the weakest performers. In AUD terms, the MSCI Small Caps Total Return Index was down by 0.7%, while the MSCI Emerging Markets Accumulation Index was up by 0.4% over May.
Over the month, the S&P500 Composite Index (0.4%) and the NASDAQ (5.8%) increased, while the Dow Jones Industrial Average declined (-3.2%), all in USD terms. In local currency terms, for the major European share markets the DAX 30 (Germany) (-1.6%), the CAC 40 (France) (-3.9%) and the FTSE 100 (UK) (-4.9%) all decreased. In Asia, the Hong Kong Hang Seng (-7.9%) and the Chinese SSE Composite (-3.6%) decreased, while the Japanese TOPIX (3.6%) and the Indian S&P BSE 500 (3.5%) increased, all in local currency terms.
The listed real assets sector produced negative returns over May. Over the month the FTSE EPRA/ NAREIT Developed (Global REITs) decreased by 3.8%, and the FTSE Global Core Infrastructure 50/50 Index returned -4.6% (both in AUD hedged terms). The S&P/ASX 300 Industry Group: A-REIT (Domestic REITs) decreased by 1.8% over May, whilst the MSCI/Mercer Australia Core Wholesale Monthly PFI NAV Post Fee (Australian Direct Property) returned 0.3% (on a one month lagged basis).
Global bond markets generated a negative return over May with the Barclays Capital Global Aggregate Bond Index (Hedged) returning -0.6% and the FTSE World Government Bond (ex-Australia) Index (Hedged) returning -0.5%. Most ten-year bond yields moved higher over the month, increasing in the UK (46bps to 4.18%), the US (22bps to 3.65%), and Japan (8bps to 0.43%), while decreasing in Germany (-5bps to 2.27%). Two-year bond yields were mixed over the month, increasing in the UK (55bps to 4.33%) and the US (44bps to 4.54%) while decreasing in Germany (-9bps to 2.70%) and Japan (-1bp to -0.06%).
Returns for most Australian bondholders were negative over May as 10-year bond yields (28bps to 3.61%), five-year bond yields (31bps to 3.38%) and two-year bond yields (48bps to 3.56%) increased.
The AUD Trade Weighted Index remained unchanged at 59.8 over May. The AUD depreciated against the US Dollar (-2.1%) and the Pound Sterling (-0.7%), while appreciating against the Euro (1.4%) and the Japanese Yen (0.5%).
Iron Ore decreased by 4.8%, finishing the month at US$100.00 per metric tonne. The S&P GSCI Commodity Total Return Index decreased by 4.1% over the month. Gold prices decreased by 1.0% to US$1,971.45 per ounce and the oil price decreased by 8.0% to US$73.18 per barrel over May.
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