Delta force

Renewed fears around the spread of a more contagious Delta variant of the COVID-19 virus, the lingering uncertainty about the inflation outlook, as well as how central banks would respond left markets treading water for much of June. Developed market equities rose by 2.4% over the month as the value rotation stalled and investors moved back into growth stocks. Emerging market equities gained a more modest 0.9% (total returns in local currency) over the month given the relatively low vaccination rates and the rise in new cases in some economies.

The mid-month meeting of the U.S. Federal Reserve (Fed) triggered a shift in market sentiment. The rather more hawkish tone at its June meeting was enough for investors to apply the brakes to the rotation to value in equity markets as the yield on longer-dated government bonds declined. The Fed indicated that the tapering of bond purchases and ultimately, the raising of interest rates may be closer than previously thought, given the sharp rise in inflation in the last few months and the realisation that not all of the upward force on inflation will be temporary.

The result weighed on longer-dated government bond yields as the market interpreted policy tightening with slowing economic activity, while also leading to a rise in shorter-dated bond yields as rate hikes were priced in. This flattening of the yield curve pushed investors away from value and back into growth stocks. U.S. Treasuries rose 0.8% and Australian Commonwealth Government bonds by 1.0% over June.

The shift in policy direction by the Fed compared to other central banks along with economic growth concerns reversed much of the decline in the U.S. dollar since the end of the first quarter. The Australian dollar was notably weaker as a result.

On the COVID-19 front, vaccination rates remain pivotal as case numbers rise in select parts of the world. Encouragingly, early indications are that the existing suite of vaccines have some effectiveness against the Delta strain, mitigating the anticipated rise in hospitalization rates or fatalities. This is a very different scenario to prior waves of COVID-19.

Economic momentum also continues to be very strong. The high-frequency forward-looking metrics, such as business surveys, have rolled off their peaks, but remain elevated in a historical context and bodes well for the global growth outlook for the second half of the year. As the bounce from pent-up consumer spending fades, we expect business spending to fill the void and respond to higher levels of demand. While the second half of the year could be bumpier for financial markets, we still expect equity markets to continue their upward path. The underlying economic and market conditions remain supportive of the reflation theme to reassert itself along with the rotation back into value. 

Economy:

• Corporate confidence and conditions remain elevated in Australia and the recent bounce in confidence is reason to believe that the economic impact from short localised lockdowns as being limited. The NAB business survey reached a record-high in May. The June releases may capture the impact of State-led lockdowns.
  (GTM AUS page 5)
• The labour market continues to improve and is on target to achieve the Reserve Bank of Australia’s target unemployment rate by year-end. Employment is above pre-pandemic levels and there is anecdotal evidence of labour shortages, but this is yet to translate to higher wages. Wage growth grew by 1.4% in the first quarter of the year.
  (GTM AUS page 8)
• Housing finance surged nearly 60% year-over-year (y/y) for April and lending for investors continues to rise. House price inflation was up 1.9% month-over-month (m/m) for the nation and 13.5% y/y. This was the fastest annual increase in national house prices since April 2004.
  (GTM AUS page 10, 11)
• U.S. economic data is robust but still somewhat mixed as the economy nears or potentially passes the peak the recovery rebound. Business surveys remain strong but the labour market has sent confusing signals of rising employment but also a higher unemployment rate. Meanwhile, retail sales have started to slow and fell 1.3% m/m for May. More concerning was the 5.0% rise in headline inflation rate for May and the 3.8% increase in core inflation. Inflation rates have been much stronger than expected, leading many to bring forward expectations for interest rate hikes by the Fed.
  (GTM AUS page 23)
• The reopening of the UK economy may have been delayed but continental Europe is pushing ahead. The eurozone economy, which started the year in recession, is on track for a strong bounce in economic growth when second quarter figures are released. Exports, industrial production, retail sale and consumer confidence have all surged in the last month.
  (GTM AUS page 27)
• G7 nations backed a U.S. minimum global corporate tax plan which would be set at a rate of at least 15%. There is still a long road to go in approving and implementing such an agreement, but this signals that the days of lower and lower taxes may be over. 

Equities:

• The ASX 200 rose 2.3% in June and 27.8% for the fiscal year, the strongest fiscal year return since 2006/07. The U.S. S&P 500 posted a similar 2.3% return, but the cyclical markets of Europe (1.6%), Japan (1.2%) and emerging markets (0.9%) lagged and the value rotation was tested as investors opted for more defensive markets. Locally, the information technology sector was the strongest with a 13.4% return for the month, followed by communication services (5.5%) consumer staples (5.3%) and consumer discretionary (4.5%). Financials (-0.2%) and materials (0.3%) were at the bottom of the table.
• Earnings expectations in most markets continue to be revised higher. Consensus data shows U.S. earnings growth of 37% this year and 44% across Europe. The consensus view is that Australia will lag with only 29% earnings growth in this calendar year. The earnings revision trend for Australia had turned down, but new data suggest things could be on the up again.
  (GTM AUS page 35)

Fixed income:

• After nearly two years of steepening, the U.S. yield curve flattened sharply following hawkish signals from the Fed’s June meeting. The yield on U.S. 10-year government bond fell 13bps to 1.45% by the end of June, and the Australian 10-year yield fell by a similar amount to 1.53%. After rising in the prior months, the decline in yields is being driven by an unwinding of inflation expectations as markets perhaps see the high rates of inflation as being genuinely transitory.
  (GTM AUS page 54)
• Credit spreads narrowed over the month with U.S. and European investment grade and high yield spreads being at or near their lowest ever. The default rate on U.S. high yield bonds fell to 1.6% for June after peaking at over 6% as recently as February of this year.
  (GTM AUS page 52)

Currencies and commodities:

• The shift by the Fed created a surge in the U.S. dollar and the U.S. dollar index rose 2.9% in June as it appreciated against nearly every currency. The Australian dollar fell by 3.1% against the greenback and spent much of June around the USD0.75 level. The U.S. dollar strength may persist in the near-term as the Fed looks to be leading the charge on policy normalization.
• A steady rise in demand and steady decline in inventories has supported the oil price of late. The price of a barrel of Brent oil rose to USD74.76 after starting the month at USD70 per barrel.
  (GTM AUS page 63)
• Industrial metal prices have come off of their peaks, as has the price of gold. Gold moves with an inverse relationship to the U.S. dollar as inflation views, a rising dollar and fading inflation risk lead to a fall in the price of the yellow metal over June. Iron ore prices surged to USD212/Mt.
  (GTM AUS page 65)

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