Weekly Market Update – 11 April 2022

Markets weaker on hawkish Federal Reserve commentary

There will be no Weekly Market Update for the next fortnight given the Easter Monday holiday next week and Anzac Day holiday the following Monday. The next Weekly Market Update edition will be delivered on Monday 2nd May.  

Global equity markets sold off last week with the MSCI World Index falling -0.9% in AUD terms. 

As mentioned in previous weeks, we have been perplexed by the recent market strength with equity markets having rallied despite the Federal Reserve’s decision to hike rates for the first time since 2018 and announce its commitment to shrink its balance sheet through quantitative tightening (QT). 

Last week markets observed a sustained hawkish rhetoric from the Federal Reserve through the release of the March FOMC minutes. The minutes showed that the consensus view amongst voting members was to reduce $60b of US Treasury notes (bonds) and $35b in mortgage-backed securities (bonds that pool multiple home loans together) starting in May. 

In addition to this, Fed officials appeared to favour a more aggressive rate hiking policy going forward suggesting 2x50bps rate hikes are likely with the market now pricing in a 50bps rate hike in May. The minutes showed that uncertainty over the Ukraine war ultimately deterred members from passing on a 0.5% hike last month. 

If we assume the Fed allows $60b of Treasury’s and $35b of mortgage-backed securities to roll off each month commencing in May, then the balance sheet would decline by more than 1trillion over 12 months reducing the overall balance sheet from 9 to 8 trillion.  

There is a substantial amount of debt to unwind here and markets last week finally appeared to digest or accept that the Fed is now very much in hawkish mode. 

Our view remains that rising rates and QT places increased pressure on economic growth. As a result, we continue to increase exposures to ‘value’ managers (VVLU, Ausbil Long Short, IXI) and reduce exposures to ‘growth’ managers (T.Rowe Price Global Equity Fund & Bell Global Emerging Companies).   

RBA finally getting back on track 

We have been vocal in our view that the RBA (like other central banks) has been ‘behind the curve’.  

Too much monetary stimulus, for too long, incorrect forward guidance on policy, incorrect forecasting of the economy, over stimulating the labour market and failing to understand the impact that the absence of migration will have on a small open economy when you grow it too fast. 

Finally, it appears as if the RBA is getting back on track.  

Last week’s RBA policy meeting (rates were left unchanged) opened a window. Forward guidance was the clear objective and by removing the word “patient” and replacing it with “the board has wanted to see actual evidence” implies greater comfort with what is likely to be accelerating inflation prints.  

The RBA has formally dropped the notion of 2024 rate hikes (which was so farfetched and reemphasises our incorrect forward guidance comments above) and we think it is plausible if not likely the RBA will commence its rate hiking schedule in June. 

This gives the board time to interpret inflation data (27 April), wages data (18 May) and employment data (19 May) before acting. 

Markets responded to the RBA announcement with a jump in front-end 3yr yields (+11bps) whilst pricing for December cash rates is now over 2%. Essentially this implies the possibility for 0.50% rate hikes too. 

Source: Pimco Investment Management  

Understanding fixed income portfolios

The below outlines some of our thought process behind the construction and composition of the Prime Defensive SMA.  

People often forget the underlying differences between equity and credit. While stock selection is all about picking winners in the equity market, the goal of credit selection is to avoid losers.  

First and foremost, credit is about getting your money back and being adequately compensated for the risk of not getting your money back. In many ways this is the same as a bank assessing a loan. Credit analysis is about assessing this potential downside or risk of a security transaction and to ensure a fair rate of interest is returned consistently over the life of the loan given the risk. 

There are two major objectives when investing: growth and income.  

Growth assets such as equities provide capital appreciation at higher levels of risk while income assets focus on capital preservation and provide regular income.  

Income assets should be utilised for stable returns while maintaining the original capital invested. The key objective to successful credit investing is avoiding losses while maintaining a steady yield. 

Successful equity investors may pick seven out of ten winners and the overall portfolio would be a success but for a credit investor these losses would significantly diminish the overall return and objective of the portfolio.  

From the borrower or issuer’s perspective it is beneficial to have solid growth prospects for its equity investors. However, it is more important to maintain liquidity to pay income on its debt or credit securities. For income investors the focus should be on the probability of the credit of a borrower deteriorating, identifying whether the yield offered compensates for this risk and then allocating investment to that security according to your risk appetite. This is the fundamental framework of credit analysis and can assist future investment decisions. 

Generally, the volatility of credit on a day-to-day basis is significantly less than equity. However, the relative absolute return on this asset class can make credit portfolios vulnerable if the credit spread or margin represents a large proportion of the return.  

Negative events are less likely to occur when investing in credit (lower risk), but the impact on portfolio returns can be substantial if proper due diligence is not undertaken. The efficient management of a portfolio becomes even more crucial in a low interest rate environment where credit markets offer lower yields.  

The idea of avoiding losers in credit portfolios is based on the asymmetric payoff in securities with optionality. While stocks go up or down, credit instruments usually have limited upside but substantial downside.  

Overall, credit is an effective investment diversification tool that offers an alternative investment solution to equities at a lower risk and provides superior returns to deposits.   

At the end of the day the goals of investing in this asset class are capital stability and income. However, the asymmetry of returns means poor credit selection can heavily impact portfolio returns. Credit (or risk) is misunderstood by many investors and the correct approach is to protect the downside rather than blindly chase yield.  

ASX Weekly Wrap

The ASX200 outperformed its global peers last week falling -0.2%. 

Growth stocks underperformed with interest rate sensitive sectors such as tech and consumer discretionary faring worst both falling close to -3%. 

Miners (-0.8%) suffered as commodity prices weakened albeit marginally. Iron ore fell -1.6% but remains above the US$150/tonne level. 

The ‘risk-off’ trade was very much in play last week with utilities the best performing sector (+3.2%). 

Traditional defensives such as staples added to portfolio performance climbing +1.7% whilst energy stocks also rallied despite a weaker oil price. The United States promising to impose fresh sanctions on Russia was the key catalyst here. 

As to be expected in a ‘risk-off’ week, large caps outperformed (-0.1%), whilst mid caps (-0.7%) and small caps (-0.9%) saw heavier selling.   

At a portfolio level, best performers in the PRIME Australian Equity Growth SMA were Spark NZ (SPK) and Endeavour Group (EDV) which both rallied around +5% on little news. Both stocks generate sustainable free cash flows and we believe are well suited to a rising interest rate environment.  

News Corporation (NWS) and OZ Minerals (OZL) were the worst performers lagging around -4%. 

In other news, Perpetual (PPT) launched a $2.4b indicative bid to acquire asset manager Pendal (PDL) last week.  

If successful, the two businesses would combine to form one global asset manager with significant scale and a strong global distribution network.  

There are many hoops to jump through but on first glance the offer from PPT seems somewhat opportunistic given the combined scrip and cash offer price of $6.23.  

PDL shares climbed +17% on the news but still trade at a -18% discount to the PPT offer price indicating investors have some initial doubts on the deal proceeding. Should the takeover proceed PPT would stand to inherit the ~$300m net cash position that currently sits on PDL’s balance sheet. 

Looking ahead

Monday 11th April 2022 – Friday 15th April 2022

  • Monday: CN Inflation Rate (MAR), UK GDP (FEB)  
  • Tuesday: AU NAB Business Confidence (MAR), UK Unemployment Rate (FEB), US Inflation Rate (MAR) 
  • Wednesday: AU Westpac Consumer Confidence (APR), CN Balance of Trade (MAR), UK Inflation Rate (MAR) 
  • Thursday: AU Unemployment Rate (MAR), US Retail Sales (MAR)
  • Friday: AU Consumer Inflation Expectations (APR), CN Unemployment Rate (MAR) 

Friday 8th April, 5pm values

 IndexChange%
All Ordinaries 7772-14-0.2%
S&P / ASX 2007478-15-0.2%
Property Trust Index1612-10-0.6%
Utilities Index7819+245+3.2%
Financials Index6762+30+0.4%
Materials Index18825-1510.8%

Friday 8th April, closing values

 IndexChange%
U.S. S&P 5004488-57-1.3%
London’s FTSE7670+133+1.8%
Japan’s Nikkei26986-679-2.5%
Hang Seng21872-167-0.8%
China’s Shanghai3252-30-0.9%

Key dividends

Monday 11th April 2022 – Friday 15th April 2022

  • Monday: Div Ex-Date – Brickworks Limited (BKW), Div Pay-Date – Adbri Limited (ABC)
  • Tuesday: Div Ex-Date – Seven Group Holdings Limited (SVW), Div Pay-Date – Blackmores Limited (BKL), Chorus Limited (CNU), QBE Insurance Group Limited (QBE), Reece Limited (REH) 
  • Wednesday: Div Pay-Date – News Corporation (NWS), Woolworths Group Limited (WOW) 
  • Thursday: Div Pay-Date – Adairs Limited (ADH), Brambles Limited (BXB), Qualitas Real Estate Income Fund (QRI) WCM Global Growth Limited (WQG)
  • Friday: N/A

Contact

Mark Johnson – Chairman of Investment Committee(03) 8825 4738
Guy Silbert – Investment Manager(03) 8825 4750

If you would like to discuss your situation, please speak to your adviser or email clientservices@primefinancial.com.au

Mark JohnsonT: (03) 8825 4738Michelle BromleyT: (03) 8825 4751
Livio Caiolfa T: (03) 8825 4748Nicole LewisT: (03) 8825 4734
Marcus AingerT: (02) 9134 6292Nicholas MillerT: (03) 8825 4722
Dylan CresswellT: (03) 8825 4707Gina McIntoshT: (07) 3557 2557
Jarrod Rodda T: (03) 8825 4729

The information in this article contains general advice and is provided by Primestock Securities Ltd AFSL 239180. That advice has been prepared without taking your personal objectives, financial situation or needs into account. Before acting on this general advice, you should consider the appropriateness of it having regard to your personal objectives, financial situation and needs. You should obtain and read the Product Disclosure Statement (PDS) before making any decision to acquire any financial product referred to in this article. Please refer to the FSG (www.primefinancial.com.au/fsg) for contact information and information about remuneration and associations with product issuers. This information should not be relied upon as a substitute for professional advice, and we encourage you to seek specific advice from your professional adviser before making a decision on the matters discussed in this article. Information in this article is current at the date of this article, and we have no obligation to update or revise it as a result of any change in events, circumstances or conditions upon which it is based.

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