Exceptional start to the year
There were no shortages of market-moving events to start the year. The inauguration of U.S. President Trump and a flurry of executive orders, a bond market sell-off which saw yields spike to 2023 highs, and challenges to the dominance of U.S. artificial intelligence (AI) all tested expectations over the duration of the equity market rally at elevated valuations. Despite a choppy start, equities rose in January and bonds had positive returns. The MSCI World index rose 3.5%, emerging market equities by 1.6%, while the Bloomberg Global Agg returned 0.6% (total returns in local currency).
Despite the numerous executive orders signed by President Trump on his first day, there was some relief that tariff policy was not as aggressive as feared. However, tariffs returned to the agenda at the month’s end after President Trump used emergency measures to enact 25% tariffs on Canada and Mexico and a 10% tariff on China, causing heavy sell-off. Several unknowns remain, including potential retaliatory tariffs, expansion of tariffs to other markets like Europe, or the duration of these tariffs given their link to non-economic parameters. However, what is certain is that “American First” policies, which boost U.S. exceptionalism, only increases global growth uncertainty.
This policy outlook is contributing to central bank policy divergence. The U.S. Federal Reserve (Fed) held rates at the January meeting, adopting a hawkish tone. The Fed is willing to be patient as it balances potential impacts on growth and inflation from policy changes. Meanwhile, other major central banks continue to cut to either build a buffer for future challenges (Bank of Canada) or to stimulate a flagging economy (European Central Bank).
Progress on lowering inflation should allow the Reserve Bank of Australia (RBA) to ease rates for the first time in this cycle, delivering on the pre-Christmas dovishness. While there are reasons for the RBA to hold rates—low unemployment rate, potential for fiscal stimulus post the Federal election and import inflation, the breadth of inflationary pressures has narrowed significantly in recent months. Over half the inflation basket is increasing by less than 3% year-over-year (y/y) and under 20% by more than 5% y/y, the lowest since the end of 2021. However, a first cut is maybe viewed as more of a policy step towards a less restrictive stance given the softer economic activity. The RBA is unlikely to rush neutral stance, preferring to verify the path of inflation in the quarterly reports and align further cuts with their quarterly forecast schedule.
The competitive moats of U.S. tech firms were called into question. While the AI investment thesis has not fundamentally changed, the pace of innovation in this space creates uncertainty over the long-term competitive nature of U.S. tech and whether the sizable capex investment is justified if technology can advance at a much lower cost. The concentration risk in equities is not new and the broadening out of earnings growth in the U.S. creates opportunities for investors across market cap size and styles.
Australian economy:
- Headline inflation for 4Q rose by 2.4% y/y, and core inflation by 3.2%. The impact of Federal and state subsidies for household electricity was notable in the inflation report, causing a 9.9% quarter-over-quarter (q/q) fall in this component. While these subsidies will be removed at some point, they may be phased out, limiting the upside to inflation when they do end.
(GTM AUS page 5) - The unemployment rate rose 10 basis points (bps) to 4.0% in December. Employment increased by 56,000 but was offset by a rise in the participation rate. Soft economic growth and a steady fall in job ads could lead to a small increase in the unemployment rate in the months ahead.
(GTM AUS page 9) - Retail sales data for November showed a 0.8% month-over-month (m/m) rise as spending was supported by discounting and heavy promotional activity. October retail sales figures were also strong (0.5% m/m) as seasonal spending started earlier this year. December figures may show some payback in retail spending.
- Business conditions improved in December, retracing some of the prior month’s weakness. However, business confidence remains subdued and well below the long-run average. The improvement may have been driven by seasonal demand and expectations for the start of the RBA easing cycle.
(GTM AUS page 6) - Housing prices were unchanged over the month at the national level, but there was a wide range when looking across capital cities. Dwelling prices fell 0.6% in Melbourne but rose 0.7% in Adelaide. On an annual basis, housing prices are 4.3% higher. Building approvals rose 0.7% m/m in December.
(GTM AUS page 10)
Equities:
- The ASX 200 was 4.6% higher in January, matching the return in Small Ords. Nearly all of the ASX 200 sectors ended the month in the green except utilities (-2.4%). The best performers were consumer discretionary (7.1%), financials (6.1%) and real estate (4.7%).
- Investors had rotated towards relatively cheaper European markets (6.1%) as views on U.S. exceptionalism were questioned and economic data was broadly supportive. However, the concerns on global trade and the rising risk of higher tariffs on Europe by the U.S. could undermine performance.
- The U.S. market rose 2.8%, Japanese equities by 0.1% and the rest of Asia-ex Japan by 0.9%. Even though the U.S. posted a positive return, the news on AI competition hit the technology sector, which fell 2.9% over the month (total return in local currency).
(GTM AUS page 34) - The U.S. earnings season was largely overshadowed by other events. However, by month-end, just under half of companies (by market cap) had reported earnings, with y/y earnings growth tracking a respectable 12.7%. Looking at the breakdown between the seven mega caps and the rest of the market, the seven mega caps have reported earnings growth of 26% y/y, and the rest of the market reported 8.7%.
- Equity valuations rose in January. The price-to-earnings (P/E) ratio on the S&P 500 rose to 21.9x, the ASX 200 to 18.4x and European equities to 14.0x.
(GTM AUS page 35)
Fixed income:
- Australian government bond yields rose over the month by 6 bps to 4.43%. The U.S. 10-year Treasury yield fell by 2 bps to 4.55 bps. The yield curve in the U.S. flattened as the Fed tilted hawkish, while the market moved to price in a February rate cut by the RBA, leading to a steeper Australian yield curve. The shifting policy mix makes Australian bonds relatively more appealing than U.S. bonds.
(GTM AUS page 51) - The monthly moves masked the large swing intra-month. Bonds sold off heavily in January and the U.S. 10-year yield spiked to 4.79% on stronger economic data, the strongest non-farm payroll report in nine months, before falling back. This was the highest yield since October 2023.
- Japanese bond yields reached a decade high of 1.25% as the Bank of Japan raised the cash rate to its highest level in 17 years.
- Riskier parts of the bond market performed well, with global high yields and emerging market debt both returning 1.2%. While the risks to growth outlook increased, the probability for recession remains low, supporting the credit market.
(GTM AUS page 54)
Other assets:
- Gold prices continue to march higher, reaching USD 2,812 by month-end, down slightly from the record high set during the month. Brent crude was up 3.1% to USD 76.90 per barrel.
(GTM AUS page 64, 67) - The USD, as measured by the DXY index, was down 0.1% for the month as investors questioned the U.S. exceptionalism trade. The euro (0.4%) and the Japanese yen (1.5%) made the most gains.
(GTM AUS page 69)
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