July 2024
Market Update

EXECUTIVE SUMMARY

  • Global and Australian equities were the largest contributors to multi-asset portfolio returns over the past 12 months.
  • Global property, global infrastructure and fixed income languished, underperforming cash returns.
  • Equity market gains were mainly driven by higher valuations (earnings multiples) rather than earnings.
  • Earnings will need to accelerate higher to justify current valuations.
  • We are focused on adding investments that enhance portfolio resilience while also picking up returns.
  • We are bullish on global infrastructure and selected actively managed funds that pay high levels of predictable income.

MARKET SUMMARY

With another financial year behind us, it is an opportune time to review the past year’s returns.
All asset classes initially faced headwinds as long-term US interest rates reached 5%, the highest level since 2006.
Their October 2023 peak coincided with the market lows.

Global equities surged in the second half, largely on the back of the US technology sector. Gains were led by NVIDIA +192%, Meta (Facebook) +76%, Alphabet (Google) +52%, Amazon +48% and Microsoft +31%.

Strong demand for cloud services and a significant rebound in online advertising are driving current big tech earnings. Investors are also becoming increasingly optimistic about future earnings as big tech invests heavily in disruptive technologies such as Artificial Intelligence.

Encouragingly, after a period of stagnation, global corporate earnings are now on an upward trajectory.

It’s a different situation in Australia. Corporate earnings have decreased due to lower commodity prices impacting the
materials and energy sectors. Big bank earnings have also remained stagnant despite surging share prices.

The chart below shows this disconnect between higher prices and lower earnings. There is clearly a lot of optimism that Australian earnings will soon recover.

International property, infrastructure, and fixed-income index funds have languished, delivering low single-digit returns over the past 12 months.

The protracted period of elevated interest rates has weighed on these asset classes.

The question now is what lies ahead.

We believe equity markets have already priced in the expectation that interest rates will move lower and earnings will accelerate higher over the next 12 months.

Therefore, allocating funds to equities at current levels needs to be done with a level of caution.

We are bullish on selected actively managed global funds that have more defensive strategies and pay high levels of predictable income.

We also favour global infrastructure because of its appealing valuation, resilient earnings, inflation-linked pricing and long-term growth potential.

The Australian economic outlook is more challenging due to persistently high inflation and the likelihood of delayed interest rate relief. This may limit short-term earnings and could result in negative outcomes such as a credit default cycle or recession.

High-quality fixed-income funds remain an important portfolio diversifier, providing some protection in the event of a global economic slowdown or shock.

Above all, we believe investors should continue to focus on quality, liquidity and diversification and avoid relying on a single economic outcome or market theme to drive returns.

Good news on the global economic front.

  • The US economy has been resilient for some time, defying earlier recession predictions.
  • The US labour market is now showing signs of cooling, reducing the risk of the economy overheating and the need for
    even higher rates.
  • Further positive news is evident in the broadening of global growth over the past few months.
  • The European economy is recovering as consumers and businesses feel more optimistic due to lower energy prices,
    reduced interest rates and improved global growth prospects.
  • Likewise, recent efforts to stabilise the crucial Chinese real estate market have reignited hopes for sustainable growth in
    the world’s second-largest economy.
  • Also catching our attention are the first interest rate reductions in Canada and Europe as confidence builds that  inflation is returning to target.
  • Whilst the hurdle for rate cuts is higher in countries like the US and Australia, these actions further support the global growth outlook.
  • In its latest economic outlook, the OECD projects steady global growth of 3.1% in 2024 (the same as in 2023),
    followed by a slight pick-up to 3.2% in 2025.


Have equity markets priced in all the good news?

  • As we know, asset prices are determined by the level of earnings and the valuation (earnings multiple) that investors are
    prepared to pay for them.
  • The earnings part of the equation benefits from a strong economy as consumers spend more and businesses invest
    more.
  • The valuation part of the equation should be pressured by higher interest rates because future earnings are worth less
    (time value of money).
  • Today’s market valuations (using 12-month expected earnings) relative to historical averages present a mixed picture.


What looks cheap:

  • Global Infrastructure trades at the -14% discount to its historical valuation average. We like Global Infrastructure for its
    resilient earnings, inflation-linked pricing and structural growth tailwinds (e.g. data centres, energy transition).
  • European equities trade at a -6% discount to their historical valuation average. European stocks share many similarities
    to US stocks (large multinationals) yet trade at much cheaper valuations.


What looks fair value:

  • Australian equities (+3% premium) and Emerging Market equities (-3% discount) are trading near their historical valuation
    averages. Both are highly sensitive to the global economic cycle.


What looks expensive:

  • US equities (S&P 500) trade at a +19% premium to historical valuation averages. We believe this is likely due to the current enthusiasm for technology and artificial intelligence, and the expectation of a significant decrease in interest rates
    soon.
  • Global equities trade at a +7% premium due to their high US weighting.

ASSET CLASS PERFORMANCE

Australian Equities

  • The S&P/ASX200 Index gained +1.01% in June, lifting its 12-month return to +12.10%.
  • At a sector level, Financials +5.07%, recorded the strongest gain in June. Commonwealth Bank shares rallied +6.56% and traded at an all-time high of $128.68 in late June.
  • Defensive sectors also performed well, with Consumer Staples gaining +4.60% and Health Care +4.34%.
  • Materials -6.53% was the worst-performing sector in June on the back of weaker commodity prices. The iron ore price slumped -9.37% and the copper price declined -5.63%.
  • For the Financial Year, the best-performing sector was Information Technology +27.98% and the worst- performing sector was Energy -7.35%.


International Equities

  • The MSCI All-World Index added +2.03% in June, marking its eighth monthly gain in the past twelve months.
  • Once again, the technology-heavy Nasdaq led US market gains, surging +6.03%. The S&P 500 added +3.59% and the Dow Jones Industrials Average gained +1.23%.
  • European stocks lagged as political uncertainty weighed on markets. The S&P Europe 350 Index declined -2.21% but is still up +12.53% over the past 12 months.
  • The S&P Japan500 Index eased -1.14% in June.
  • The Dow Jones Emerging Market Index added +2.85% in June, buoyed by gains in Indian equities as the S&P China500 Index lost -2.33%.


Property and Infrastructure

  • Australian and International Property increased by +0.39% and +0.37% in June.
  • A +74% gain in ASX-listed Goodman Group (40% of the Australian property index) is the difference in 12-month returns favouring Australian property +24.65% over International Property +6.61%.
  • Global Listed Infrastructure (Hedged) declined -2.58%.


Fixed Income

  • The Bloomberg Australian Bond Index gained +0.92% in June.
  • The 10-year Australian government bond yield eased to 4.35% from 4.40% a month earlier.
  • The RBA maintained interest rates at 4.35% for a fifth consecutive meeting in mid-June and reiterated that it is “not ruling anything in or out” regarding future policy decisions.
  • All eyes will be on the June quarter CPI inflation print (31 July) ahead of the RBA’s 6th August interest rate decision.
  • As of early July, markets had priced in a roughly one-in-three chance of a rate hike at this meeting.

 

As always if you require more information please don’ hesitate to contact me.

Philip Connor-Stead AFP® Adv. Dip. FP
Principal
New Horizon Wealth

Authorised Representatives of Lifespan Financial Planning Pty Ltd ANB 23 065 921 735 AFSL 229892