Weekly Market Update – 9 May 2022

Volatility spikes amid interest rate hikes

Global equity markets were once again volatile last week. The MSCI World index fell -1% in AUD terms.  

A more dovish or less aggressive outlook for the pace of interest rate rises from the Federal Reserve saw equities climb higher in the first half of the week, however, ongoing concerns around inflation (the Bank of England warned investors inflation could reach 10% by year’s end) dragged equities lower in the back half.   

Whilst equity markets had correctly priced in a 50bps rate hike from the Federal Reserve (which was duly delivered) Chairman Jay Powell pulled back on market speculation that the FOMC may be inclined to deliver a 0.75% hike in the coming months to combat rampant inflation. 

The Fed indicated that another 3x50bps rate hikes were likely, but this in effect soothed investor concern which had begun to price in the prospect of even larger adjustments to the cash rate. 

Further to this, the Federal Reserve delayed the commencement of quantitative tightening (QT) to June with most having expected this to begin in May. QT is the opposite of quantitative easing (QE) and in effect means the Federal Reserve allows the bonds and other assets it purchased during QE to mature without repurchasing or rolling them over. This essentially withdraws liquidity from the financial system. 

On top of delaying the beginning of QT, the FOMC also announced that it would begin shrinking its balance sheet by $47.5b per month from June-September before increasing this monthly figure to $90b in September. 

Given markets had been preparing for a significantly higher monthly roll-off figure than this $47.5b, it was no surprise that equities rallied and the USD weakened immediately after the FOMC announcement.  

It is worth highlighting the link between market expectations vs actuals. Expectations had been for a significantly higher QT figure starting immediately so taking more aggressive measures off the table and thus removing a more hawkish potential outcome was a boon for risk assets (which rallied +3% on Wednesday).  

In terms of the outlook for inflation, Powell commented that the Federal Reserve now have a good handle on inflation and for these reasons expect it would peak in the near future. A near-term peak in inflation is considered essential to ensure the US economy avoids a hard landing recession in favour of a soft landing.  

A soft landing implies a cyclical slowdown in economic growth, bringing inflation down and avoiding a recession whereas a hard landing refers to a severe slowdown following a period of rapid growth which can trigger a recession. 

Following the COVID-19 recovery and record low interest rates which have fuelled extensive borrowing and triggered a forty-year high inflation figure we remain cautious for equities. 

We see short-term upside in US equities following a calmer and more dovish Federal Reserve response last week but longer term we continue to remain weary of slowing global growth and deteriorating consumer confidence and PMIs.  

What the Federal Reserve should have done and how we have positioned the Prime International Equity SMA  

We would argue the Federal Reserve should have commenced QT now at a more aggressive $90b run rate, simply because we think that retaining QE for so long was a policy error that has exacerbated inflationary issues.  

In our view delaying the unwinding of the Fed balance sheet further perpetuates asset market bubbles which at some stage have to deflate. That being said, we acknowledge we are now on the right path towards tackling these issues which is a step in the right direction. 

The Prime International Equity SMA recently rotated out of our global consumer staples and value ETF exposure and reallocated the proceeds into a global banks ETF and a broad-based US equity ETF. 

The strategy behind these moves was to rotate away from value to growth and also rotate sectors. This is designed to increase the overall beta of the portfolio and capture more alpha if the market bounces higher in a short-term rally.  

A portfolio’s beta measures the overall risk or volatility of the portfolio, so a higher beta typically produces a better payoff in a rising market and a lower overall beta tends to produce a better payoff in a falling market.  

We view this move as short term in nature and will look to increase the portfolio’s value tilt on any market strength.   

Implication from RBA rate hike 

The Reserve Bank hiked rates last week too in a sign it was no longer willing to sit back and allow inflation to run further.  

Unfortunately, we would argue that inflation has further to run locally with global supply chains already under pressure, increased bottlenecks in manufacturing arising because of COVID lockdowns in China and the flow-on effects from the floods that ravaged the east coast of Australia earlier this year. 

The 0.25% rate hike which most pundits had not expected showed the RBA had become too impatient to wait for May’s wages growth data due in a fortnight’s time. 

The RBA had previously stated (on multiple occasions) that wages growth would dictate its response to rising inflation, so it is safe to say the RBA is hoping for strong growth in wages data when it is released. A ‘miss’ here would put further strain on households with ‘real’ wages (real meaning adjusted for inflation) already under heavy strain.  

Unsurprisingly REITs were the major underperformers across the ASX last week.  

Rising interest rates pose challenges for REITs. All else being equal, higher interest rates tend to decrease the value of properties and increase REIT borrowing costs. In addition, higher interest rates make the relatively high dividend yields generated by REITs less attractive when compared with lower-risk, fixed income securities, which reduces their appeal to income-seeking investors. 

Goodman Group (GMG) and Waypoint (WPR) were both materially weaker over the week falling -13% and -7% respectively.  

The Prime Growth Equity SMA holds GMG and WPR in the portfolio believing they are quality assets providing stable and secure income for investors. We continue to monitor valuations across the REIT sector and would look to add to quality holdings where appropriate if the market draws down further. 

Australian Private Debt, a New Asset Class? 

Although the Australian private debt market is one of the largest and more diverse asset pools domestically, it is largely unknown to most investors. 

Historically, the sector’s funding needs were almost entirely met by the traditional banking system. However, recent regulatory reform, customer specialisation requirements and the non-vanilla nature of cashflows have seen the market run to institutional financing.  

Complementing these supply-side drivers is the asset class’s uniquely risk profile: typically, commercial real estate (CRE) debt is secured over real assets and floating rate in nature. These features mean private debt provides ideal positioning within the interest rate and credit cycles. 

The CRE loan market is a major but specialised subset of the Australian private debt universe. This sector comprises approximately a third of the aggregate corporate loan book for domestic authorised deposit-taking institutions (ADIs).  

As opposed to typical corporate lending, CRE debt funding will revolve around a particular commercial property asset which can vary in terms of stages of development, seniority, geography, use of the underlying asset and timing of cash flows. 

Consequently, expertise is necessary to navigate this complex market.  

Critically, the lender must ensure processes at both the origination and monitoring stages are robust enough to prevent capital losses. This became apparent during the global financial crisis when the loose lending practices of the Australian banks, elevated leverage of borrowers and deteriorating economic conditions resulted in significant impairments to some CRE loan books.  

As a result of the inherent complexity, with appropriate risk management, CRE lending can generate excess returns with limited capital volatility; this is currently being achieved by a number of non-bank CRE lenders.  

While the broader property asset class will always remain cyclical, the risk profile of CRE has materially improved in the past decade. 

Although the direct and indirect (via property funds) purchase of CRE has been a popular investment strategy domestically for decades, we believe investor knowledge of the CRE debt market is limited. 

Overall, this market represents an attractive investment opportunity and will continue to be an important pillar of the emerging an ever-increasing Australian private debt institutional asset class.  

ASX Weekly Wrap

The ASX200 underperformed the global benchmark falling -3% last week.  

Utilities (-0.3%) and energy stocks (-0.1%) provided some respite for investors in what was really a broad-based selloff.  

Energy stocks benefitted from a 3-5% rally in the oil price, which strengthened as imminent European Union sanctions on Russian oil increase the likelihood of tighter supply. Santos (STO) was one of two stocks in the Prime Australian Equity Growth SMA which finished the week higher rising +0.6% as a result.  

Sectors leveraged to low interest rate environments were naturally the worst performers with REITs and tech falling 6-8% over the course of the week. 

Naturally, in a risk-off environment, quality and large caps proved to be the safest segment of the market. Large caps fell around -3% compared to mid caps (-4.5%) and small caps (-5.3%). 

Amcor (AMC) was one of the best performers on the market last week rising +5.4%. AMC is a core holding in the PRIME Diversified Income SMA and was stronger after posting its Q3 update which showed a +15.6% increase in net sales and a +7.2% increase in gross profit. 

We thought this was a very strong update given the pressures we continue to see around global supply chains and retain our holding.  

Looking ahead

Monday 9th May 2022 – Friday 13th May 2022

  • Monday: CN Balance of Trade (APR) 
  • Tuesday: AU NAB Business Confidence (APR), US NFIB Business Optimism Index (APR) 
  • Wednesday: AU Westpac Consumer Confidence (MAY), CN Inflation Rate (APR), US Inflation Rate (APR) 
  • Thursday: AU Building Permits (MAR), CN M2 Money Supply (APR), UK GDP (MAR), Balance of Trade (MAR), US PPI (APR) 
  • Friday: N/A 

Friday 6th May, 5pm values

 IndexChange%
All Ordinaries 7468-257-3.3%
S&P / ASX 2007206-229-3.1%
Property Trust Index1495-134-8.2%
Utilities Index8223-25-0.3%
Financials Index6614-169-2.5%
Materials Index17353-562-3.1%

Friday 6th May, closing values

 IndexChange%
U.S. S&P 5004123-9-0.2%
London’s FTSE7388-157-2.1%
Japan’s Nikkei27004+156+0.6%
Hang Seng20002-1087-5.2%
China’s Shanghai3002-45-1.5%

Key dividends

Monday 9th May 2022 – Friday 13th May 2022

  • Monday: Div Ex-Date – ANZ Bank (ANZ), Div Pay-Date – Metrics Master Income Trust (MXT), Metrics Income Opportunities Trust (MOT) 
  • Tuesday: Div Pay-Date – NB Global Corporate Income Trust (NBI) 
  • Wednesday: Div Ex-Date – ResMed Inc (RMD) 
  • Thursday: Div Pay-Date – Newmark Property Trust (NPR) 
  • Friday: Div Pay-Date – Soul Pattinson (SOL), Waypoint REIT (WPR) 

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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