In this update we review the June quarter and financial year, outline what we consider to be the major economic theme driving the market in 2023 and provide a market outlook.
The last year was yet another reminder of just how hard it is to time markets. Just when everyone was most gloomy about inflation and interest rates, share markets rebounded.
From the market lows experienced in early October 2022, equity markets have experienced a strong rebound. The recovery has been far more convincing in the US, where the S&P 500 is trading 26% above the October lows. Most of the rebound can be attributed to the magnificent 7 (Apple, Microsoft, Nvidia, etc), with the remaining 493 stocks tracking sideways. Enthusiasm for AI and its potential to boost productivity following the release of ChatGPT in late 2022 provided a boost for tech stocks.
During the quarter commodity prices weakened significantly, with metals down 8.8%, Wheat down 8.1%, Oil down 6.6% (down for a 4th consecutive quarter) and thermal coal down 27.8%. All of which is good news in the fight against inflation.
Every year has a major economic theme that drives the market.
In 2020 it was the COVID-19 induced recession. 2021 it was policy supported reflation. Last year worries about inflation, recession and geopolitics drove poor returns in 2021-22. A relaxation of worries about these things drove a strong rebound in returns over the last financial year: While inflation rose to its highest in decades in 2022, it peaked in the US a year ago and has been trending down since with other countries following suit. This reflects improved goods supply, lower commodity prices, lower transport costs and easing demand. This should enable central banks to start easing monetary policy through next year to at least avoid a deep recession.
The outlook for the Australian economy is mixed.
The RBA initially expected the cash rate to be raised anywhere from 3.5% to 4%, currently it is 4.10%. While central banks still worry about sticky services inflation in the face of stronger wages growth, signs of cooling economic growth and slowing job openings have started to ease concerns on this front.
Chart 1 – RBA Cash Rate Outlook – Rates expected to peak by September 2023, and rate cuts to start somewhere between March and September 2024
Source – Goldman Sachs Global Investment Research, Bloomberg
Labour markets remain very tight. The unemployment rate has been stable around 3.50% but remains below the RBA’s natural rate of unemployment of around 4%. The number of unemployed workers per vacancy remains very low at 1.2, far below the pre-pandemic level of around 3. With net immigration expected to close to 400,000 in FY 24, tight conditions in the labour market should ease somewhat. Unemployment is expected to rise, with some forecasts as high as 5.3% by 2025.
The Australian government’s budget surplus is swelling courtesy of strong jobs growth and large mining profits. Figures from the Department of Finance exhibited an underlying cash surplus of A$19 billion in the 11 months to May end. That put it on track to be the largest on record.
During the FY 2023 Australian residential property prices fell 5.3%, reflecting a sharp fall in the second half of 2022 as higher mortgage rates hit. The market saw some recovery in the last 5 months as immigration rebounded and supply fell. Australian capital-city dwelling prices rose +1.2% mom in June. CoreLogic noted ‘persistently low levels of available housing supply running up against rising housing demand’. Rising rents support price rises. As foreshadowed last quarter, there is a need for an increase in housing construction.
The two-speed consumer. Discretionary spending under pressure due to the impact of rising interest rates.
Official data from the ABS, as well as third-party data from Visa suggests that discretionary spending is under pressure as the impact of interest rate increases are being felt. Younger age groups including renters and first-time homeowners are the most affected, as rising rent and interest payments hit household budgets. Data from the CBA shows that spending for those aged 18-54 is below inflation, implying volumes are declining. Those over 54 continue to spend as income from savings is boosted by the higher interest rates.
Chart 2 – Older consumers continue to spend as younger consumers are pulling back.
Source – Visa, Macquarie Research
Chart 3 – Discretionary spending has been contracting for almost a year.
Easing inflation has been driven by goods prices but is still too high.
Inflation in most major economies is moderating. In Australia, inflation pressures have eased over recent months but remain too high. Housing inflation remains elevated, with an acceleration in rents. Inflation is also strong across a range of services including education, medical services, and insurance, while goods inflation eased in part due to disinflation in globally traded goods such as furniture and household appliances. China remains the largest Global Manufacturer. China Producer Price Index is deflating which is positive for future global goods-based inflation.
Chart 4 – Underlying inflation is still tracking around 5% Gradual disinflation is expected going forward.
Source: Goldman Sachs Global Research, ABS
Chart 5 – China Producer Price Index is deflating.
Source Alpine Macro
Long term, Australia is better positioned than most countries given it is a net exporter of food, has extensive thermal coal, gas, iron ore resources, green minerals (lithium, copper, nickel) and strong population growth. Case in point Australian resource and energy exports climbed 9% to a record A$460 billion ($300 billion) in the financial year just ended.
Investment Strategy – There are always opportunities in Stock / Sector Selection
In the Australian market we continue to hold a balanced portfolio structure across Growth (Information Technology, Logistics, Healthcare, International), Defensives (Consumer Staples, Infrastructure, Gold) and Cyclicals (Resources, select Financials).
Resources exposure is a mixture of BHP, Northern Star, Mineral Resources and Lynas. Financials exposure is primarily CBA and Macquarie. Defensives include consumer staples (Coles, Woolworths), infrastructure (Transurban), and logistics (Goodman Group).
International exposure includes both domestically listed international stocks such as CSL, and Resmed. Along with key international stocks listed overseas such as Microsoft, Apple, and ASML.
Please let us know if we can be of any assistance, or if you would like to discuss.