Tale of two markets

Global equities were weak in May as the MSCI AC World index fell by 1.3% on the month. Developed markets (-0.1%) did slightly better than emerging ones (-1.0%), which were weighed down by China. But even within developed economies the divergence was clear as the narrow rally in technology related names helped keep the S&P 500 aloft and Japan’s TOPIX surged to a 33 year high by gaining another 3.6% in May. Meanwhile, European markets suffered given their reliance on Chinese growth.

The performance of equities continues to mask the growth risks reflected in bond markets. The Global Aggregate Index fell 2.0% on the month as bond yields surge in response to risks around the debt ceiling and potential for further rate hikes from the U.S. Federal Reserve. Commodities were also weaker on growth concerns and rising U.S. dollar.

There were several themes that drove the market in May:

• The U.S. debt ceiling debate moved a step closer to resolution at the end of the month, but the path was not easy. The proposed deal that went to the House at month-end saw the limit deferred until 2025 and avoided the disastrous possibility of a default.
• The persistence of core rate of inflation across the developed world continues to haunt markets. The UK was a front runner as core inflation rose to 6.8%, a 31 year high.
• China’s growth recovery fades as many economic data points missed expectations and further policy measures to steady growth remain absent. Full year growth will likely be above the policy target of 5%, but much lower than hoped just a couple of months ago.
• Japan starts to fire on all cylinders as inflation lifts, along with growth prospects, which adding to the optimism. A string of policy measures to improve corporate governance and higher levels of stock buybacks also supported valuations of Japanese equities.
• Artificial intelligence turbocharges the returns for a few companies propelling U.S. equities higher on narrow leadership. Excluding the big AI related names, the U.S. S&P 500 would be in negative territory for the year.

The cautious positioning in equites and preference for high quality fixed income was challenged in May as equities moved higher as did bond yields. However, with many large cap U.S. companies at elevated valuations the risk-return still favours bonds given the risks to the economic outlook.

Economy:

• The Australian Government Budget posted the first surplus since 2007/08, with a material improvement in the fiscal position over the forecast horizon of $125.9bn. The upgrades to the outlook come from higher tax income and higher commodity prices. However, the fiscal thrust to the economy is anticipated to be fairly small, leaving economic forecasts unchanged.  
• A higher-than-expected monthly inflation print (6.8%) for Australia raised alarm bells that the Reserve Bank of Australia (RBA) would need to do more. The inflation pressure from the housing market as well as higher wages is expected to keep core rates of inflation above the RBA target for some time.
• Consumer confidence fell in May by 7.9% to 79.0 and is well down from the peak of 118.8 in April 2021 . Meanwhile, business confidence ticked up by a marginal 1.3pts to 0.3.
  (GTM AUS page 7)
• April’s larbour market data showed employment contracted by 4,000 jobs and the unemployment rate rose to 3.7% as the fall in jobs offset the decline in the labour supply.
  (GTM AUS page 8)
• Housing market stabilization continued as house prices rose by 1.4% month-over-month (m/m) nationally in May. Having gained 2.8% since February, prices are now 6.8% below their level a year ago. The robust auction clearance rates suggest that prices may be supported in the coming months.
  (GTM AUS page 10)
• Contrasting the moves in prices, other housing data has been less supportive. Building approvals fell 8.0% m/m in April to their lowest level since 2012. The conflicting price and volume signals make for a tricky monetary policy stance.

Equities:

• Australian equities fell through May on a combination of global growth factors (China and the U.S. debt ceiling) as well as a hawkish turn by the RBA. The ASX 200 was down 2.5% for the month.
• Developed market equities were flat over the month (-0.1%) while the Japanese market was up 3.6%, the S&P 500 gained 0.4% but the European equity market fell 2.8%. Emerging markets were down 1.0%.
  (GTM AUS page 35)
• At the sector level there was daylight between the best sector and the rest. The strongest gainer in the ASX 200 was IT (11.6%) followed by utilities (1.1%). At the other end of the table were consumer discretionary (-6.1%), consumer staples (-4.6%), materials (-4.4%) and financials (-3.2%). Small cap Australian stocks also underperformed the large cap as the Small Ordinaries index fell 3.3%.
• Equity valuations out of the U.S. continue to sit around average levels. The ASX 200 at 14.3x forward price to earnings (P/E)  is in line with its long run average.  Out of the major markets, the U.S. is trading above average at 18.5x P/E but well below the lofty highs prior to the pandemic.
  (GTM AUS page 36)

Fixed income:

• The yield on the Australian 10-year government bond was 26bps higher on the month to 3.60% on the resumption of rate hikes, as the cash rate rose to 3.85%. U.S. 10-year yields were also higher at 3.64% as the market increased the likelihood of more to come from the Fed.
  (GTM AUS page 51)
• Credit markets recorded declines over the month as spreads widened with rising government bond yields. In investment grade bonds, the Australian index fell by 0.5% and the global investment grade index was down 1.9%.  Meanwhile the global high yield bond market fell by 0.6%.
  (GTM AUS page 49)

Other assets:

• Commodity prices fell across the board in May as the Bloomberg Commodity Index fell 6.1%, largely driven by declining oil prices. The price of Brent oil fell to US$73 per barrel, a nearly 11% decline on the month, given the weakness in Chinese growth and anticipated fall in demand.
  (GTM AUS page 63)
• Iron ore prices fell to US$100/Mt on both seasonally weaker demand and Chinese growth narrative. The PMI for manufacturing in China fell to 48.8 in May, indicating a contraction in the manufacturing sector.
• Even the gold price was not immune to selling pressure as it fell to US$1,962. Investors are holding gold to increase diversification but even the yellow metal is susceptible to a rising U.S. dollar and potentially higher cash rates.
  (GTM AUS page 66)
• The US dollar index gained 2.6% in May and was up against most major currencies. The Aussie dollar fell by 2.1% but the euro fell by 3.4% against the Greenback. The Chinese RMB was 2.5% higher.
  (GTM AUS page 68)