Soft serve
Economic data was weaker around the world in June, putting the ‘soft’ back into the soft landing and unwinding concerns that some economies (e.g. the U.S.) may run ‘too hot’ for inflation to fall. Some developed market central banks have now started their rate cutting cycle to support growth as inflation pressures fade, but the pace of policy easing will be more modest compared to expectations a few months ago. Australia is proving an exception to this view, as inflation is looking more stuck than sticky, creating a bias for further tightening.
Politics was firmly on the agenda in June as elections were called in the UK and Europe. In the UK, the election outcome is less about who will win, but by how much, given the hefty lead in the polls by the Labour party. Meanwhile, in Europe, the outcome of the European Parliamentary elections resulted in a decisive shift to the right. The result led to a snap election being called in France, with the far-right and far-left leaning parties performing strongly in the first round of voting.
In the U.S., the election campaigning is gathering pace, but neither candidate is laying out any plans to reduce spending or meaningfully raise taxes to address the ballooning fiscal deficit. A less fiscally prudent U.S. government could spark another period of rising inflation.
Fixed income markets have languished over the first six months the year. Easing inflation pressures and the onset of rate cutting cycles should mean lower yields on core government bonds. However, politics have complicated the picture as markets may reprice the inflation outlook given long-run spending plans of incoming governments. Core government bond yields are likely to remain range bound, and investors should be wary of adding too much duration to portfolios until the outlook is clearer.
Equity markets moved higher in June and the MSCI World Index rose 2.4%, helped by the better performance of U.S. and Japanese markets as Europe lagged. Emerging markets outperformed (4.3%), supported by the artificial intelligence (AI) exposed markets in Taiwan and Korea, which are large weights in the index.
However, the narrowness of the U.S. rally is again in focus as the AI names dominate performance. Over the second quarter, the U.S. S&P 500 was up 4.3%, but the equal weighted index has fallen 2.6% over the same period. A broadening out in the U.S. market is expected given the improving earnings outlook in the non-AI related names and relatively better valuations. Similarly, while the European market has been buffeted by politics, the cyclical improvement in the economy and over-discounted nature of the equity market provides ample opportunity for active stock selection to generate returns.
Australian economy:
- Inflation surged to 4.0% year-over-year (y/y) in May, well above expectations and was the fastest pace of monthly price rises since November 2023. This followed the higher April monthly figure and suggests the full quarterly figure will be above the Reserve Bank of Australia’s (RBA’s) inflation forecast, putting pressure on them to raise rates in August.
(GTM AUS page 5) - The RBA kept the cash rate steady at 4.35% in June and the commentary shifted in a hawkish direction. The statement brought back the commitment to getting inflation back to target and suggests the RBA’s tolerance for inflation is wearing thin. The biggest hurdle for the RBA is communicating any further tightening in policy, just as inflation is likely to fall given the impact of government subsidies that begin in July.
(GTM AUS page 54) - Retail sales were soft in April, with a 0.1% gain month-over-month (m/m) and follows from the March decline of -0.4% m/m. Speculation around further monetary policy tightening is likely weighing on consumer sentiment and behaviour.
- The unemployment rate fell by 0.1% to 4.0% in May, but the April and May reports were distorted by the higher than usual number of people that were identified as unemployed in April but waiting to start work in May. Taking the April and May labour market data together and comparing it to March suggests the ongoing cooling in the labour market.
(GTM AUS page 9) - House prices continued to rise in June, and the national index rose by 0.7% m/m and by 8.3% y/y. Regionally the price movement is diverse as Brisbane (1.2% m/m) and Perth (2.0% m/m) reported strength, contrasting the muted moves in Sydney (0.5% m/m) and Melbourne (-0.2% m/m). Tight supply is underpinning the price growth nationally, but an expected slowdown in migration and potential for further rate hikes may cool housing market activity.
(GTM AUS page 10 and 11)
Equities:
- The MSCI World index rose 2.4% in June and the S&P 500 by 3.6%, outperforming the 1.0% gain for the ASX 200. European stocks (-1.4%) lagged as political uncertainty weighed on markets. Japanese equities gained 1.7% and the rest of the APAC region outperformed developed markets. The MSIC Asia ex-Japan index rose 3.8% and helped the broader EM equity index to a 4.3% return for the month.
(GTM AUS page 31) - The re-rating in equity markets accounts for a large share of this years returns, and many equity markets are no longer cheap. The U.S. equity market is trading at 21.0x on a forward price-to-earnings (P/E) basis. Meanwhile Australia at 16.8x P/E is one standard deviation above its long run average. Even Japanese and European equities are trading inline with long run averages at the index level. The rising valuations in equities stresses the need for an active approach to equities to find value while avoid the traps.
(GTM AUS page 32) - Earnings expectations have remained consistent across markets for 2024, with an expected pick up in 2025, which is helping investors justify the higher valuations.
(GTM AUS page 33) - At the sector level, the financial sector recorded the strongest gain (5.1%) in May, followed by consumer staples (4.6%), utilities (4.6%) and healthcare (4.4%). Materials was the worst performing sector (-6.5%), while energy (-1.6%) and industrials (-0.2%) were also in the red for the month.
Fixed income:
- Australian government bonds yields fell by 10 basis points (bps) over the month to 4.31% and the U.S. 10-year Treasury yield declined by 12bps to 4.37%, but this masked a late month rise from much lower levels.
(GTM AUS page 50) - More broadly, the benign macro environment supports the extended parts of the fixed income market such as investment grade and high yield bonds. Both segments of the credit market rose in June in Australia and globally. The positive corporate earnings and contained defaults rates are keeping spreads tight.
(GTM AUS page 51)
Other assets:
- Commodity prices were mixed in June. The price of Brent oil rose 7% to USD 86 per barrel, gold lost some of its shine falling by 0.7% to USD 2,331, but other metals suffered through worse performance. Aluminum was down 7.2%, and nickel fell 14.5%.
(GTM AUS page 67) - The iron ore price has been slow to adjust to the outlook for Chinese demand, confounding some investors. The price was down 9.4% to USD 107, but from an elevated level. Chinese steel output has been resilient, creating demand for iron ore. however, an increasing share of the production is being exported from China.
- The U.S. dollar index was 1.1% higher in June and the Australian dollar (AUD) index gained 0.9%. The repricing of the rates outlook supported the AUD vs the USD and the currency rose 0.4% to AUD 0.668.
(GTM AUS page 69)
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