June 2024
Market Update

EXECUTIVE SUMMARY

  • Global business surveys point to stronger and broadening economic growth.
  • Commodity markets are not fully buying the growth story, with copper rallying but the oil price easing.
  • I remain focused on diversification and positioning portfolios towards investments that can perform well in different economic scenarios.
  • I like Global Infrastructure for its attractive valuation, resilient earnings, inflation-linked pricing and long-term growth potential.

MARKET SUMMARY

Global equity markets recovered in May. The US S&P500 Index gained +4.96% and Australia’s S&P/ASX 200 Index added +0.92%.

The run of resilient growth and stubbornly high inflation data continued in May. Equity markets have focused on the positives, particularly the broadening of growth into the major economies of Europe and China.

Last year’s Chinese economic recovery came after the government abandoned its “Zero COVID” policy in late 2022. More recent efforts to stabilise the real estate market have renewed hopes for sustainable growth. The International Monetary Fund has raised its Chinese growth targets to 5% and 4.5% for the next two years.

Over the past few years, Europe has also had to contend with several challenges. A gas price spike in 2022 hit the manufacturing sector and consumers, who were also grappling with significantly higher interest rates. Attention has shifted to an improving manufacturing sector and potentially lower interest rates in the months ahead, which means the European economic recovery could have legs.

JP Morgan’s Global Composite PMI is a leading indicator of global growth. Each month, around 27,000 manufacturing and service sector companies in over 40 countries are surveyed on their current situation and future intentions.

The latest survey (5 June) was headlined, “Growth rate of global economy accelerates to fastest in a year during May”. It concludes, “…gains in the new orders, employment and future activity also bode well for sustaining the recovery in the coming months, as does the broadening of the base of the upturn.”

Commodities markets are not fully buying the global growth story, with copper rallying but the price of oil easing.

On the topic of copper, it is difficult to overlook BHP’s recent activity in this sector. Copper lies at the heart of its US$49 billion tilt for UK-based Anglo-American (since pulled), which came after its US$6.4 billion acquisition of Australian copper miner Oz Minerals last year.

Copper is central to BHP’s growth strategy and its plans to reduce its earnings dependency on iron ore. BHP is betting that supply will struggle to keep pace with the demand for the metal to build renewable energy infrastructure, energy storage systems and electric vehicles (EVs).

Another consequence of stronger economic conditions is persistent inflation and a higher interest rate outlook. US and Australian rate cut expectations have been significantly pushed back since the start of 2024.

In January 2024:

  • 6 US interest rate cuts were expected this year, and now it is 2.
  • 2 Australian rate cuts were expected this year, and now it is 0.

The current macro set-up of broadening growth, persistent inflation, and higher interest rates favors economically sensitive exposures such as Emerging Markets, European, Equal-Weight US equities, and Floating- rate Bonds.

I remain focused on diversification and positioning portfolios towards investments that can perform well in different economic scenarios.

I particularly like Global for its attractive valuation, inflation-linked earnings, structural growth opportunities and earnings resilience should an unexpected downturn occur.

Are Australian interest rates high enough?

  • Since May 2022, the RBA has raised interest rates by a total of 4.25% to reach the current level of 4.35%.
  • Other major central banks have been even more aggressive. Policy rates in the US, New Zealand and the UK are at or above 5%.
  • The RBA hoped it could do less due to Australia’s greater exposure to variable mortgage rates.
  • This view is now being challenged as Australian inflation remains significantly above the RBA’s 2% to 3% target range, printing 3.6% in annual terms in April 2024 (3.4% expected).
  • The RBA recently increased its year-end 2024 inflation forecast to 3.8% from 3.2% in February and warned of lingering inflation pressures.
  • From the RBA’s 7 May policy statement (our emphasis): “Recent data indicate that, while inflation is easing, it is doing so more slowly than previously expected and it remains high. The Board expects that it will be some time yet before inflation is sustainably in the target range and will remain vigilant to upside risks. The path of interest rates that will best ensure that inflation returns to target in a reasonable timeframe remains uncertain and the Board is not ruling anything in or out.”
  • Looking ahead, there are reasons to believe that inflation will continue to stay high
  • The jobs market remains tight, property and equity markets are strong (wealth effect), the rolling off of fixed- rate mortgages has almost run its course and income tax cuts come into effect on 1 July 2024.
  • The recent Federal Budget is stimulatory, increasing demand and risks stoking broader inflation.
  • As shown below, the current situation of higher US than Australian interest rates is unusual and raises the question of whether Australian rates are sufficiently high.

Global Infrastructure fundamentals are attractive.

  • The earnings of Global Infrastructure companies* have roughly quadrupled since December 2009, as shown by the blue bars in the chart on the next page.
  • Earnings grew consistently throughout the decade to the pandemic, then declined as lockdowns hit traffic volumes (e.g. airports, toll roads) before recovering again.
  • Earnings have surged to record levels in early 2024 as new projects and inflation-linked pricing have kicked in.
  • The lagging performance of Global Infrastructure assets on the stock market has created an opportunity to add exposure at historically cheap levels. The current trailing earnings multiple of 15.5x is the lowest on record.

 

* As measured by the FTSE Developed Core Infrastructure 50/50 Index.

We favour Global Infrastructure over Fixed-rate bonds.

  • Australian and US Government fixed-rate bonds are highly defensive and will return roughly 4-5% pa over the next 4-6 years (yield to maturity).
  • The capital value of these bonds will fluctuate with changing interest rate expectations. Falling rates are positive for fixed-rate bond pricing. However, resilient economic growth and sticky inflation (as currently being experienced) reduce the chances of significant rate cuts and capital upside.
  • Global Infrastructure also has defensive characteristics (essential services) and benefits from lower interest rates through lower debt servicing costs and higher valuations. However, it also has multiple earnings growth levers, so it is not simply an interest rate play.
  • Global infrastructure assets have usage prices linked to economic activity, commodity prices, and inflation, all of which are tailwinds to earnings.
  • Several big global trends also underpin a solid growth outlook for Global Infrastructure:

 

  1. The trend towards onshoring as companies rebuild supply chains following the pandemic disruptions,
  2. The AI boom and demand for data centres and associated infrastructure,
  3. Electricity grid investment to support these data centres,
  4. Favorable government policy towards the energy transition to renewables.

 

* Global Infrastructure assets are currently paying distributions of 3-4% pa, which will likely grow over the next 4-6 years (in line with stronger earnings).

ASSET CLASS PERFORMANCE

Australian Equities

  • The S&P/ASX200 Index gained +0.92% in May, lifting its 12-month return to +12.93%.
  • The best-performing sector was Information Technology +5.42%, mirroring the strong performance of the US Nasdaq technology index.
  • IT sector leaders Xero +10.58%, NEXTDC +6.59% and WiseTech +4.18% all traded strongly.
  • Utilities +3.38% was the next best performing sector, boosted by AGL’s profit upgrade and its +8.14% share price rally.
  • Communications -2.63% fared worst as investors reacted negatively to Telstra’s market update, highlighting the challenges in mobile markets and its enterprise segment. Its shares declined -5.45% in May.


International Equities

  • The MSCI All World Index reversed April’s losses, adding +3.70% in May. The 12-month return stands at an impressive +24.01%.
  • The major US stock market indices all saw gains, although to varying degrees. The Nasdaq gained +6.98% on the back of Nvidia’s better-than-expected earnings result and record share price. The S&P 500 added +4.96% and the Dow Jones Industrials Average gained +2.58%.
  • Healthy gains were also enjoyed on the other side of the Atlantic, with the S&P Europe 350 Index advancing +5.02%. European stocks are benefiting from greater economic optimism, cheaper valuations (than US stocks) and likely lower European interest rates in the months ahead.
  • The S&P Japan500 Index delivered a modest +0.95% gain in May. A weaker yen has led to concern about the risk of imported inflation weakening domestic demand.
  • The Dow Jones Emerging Market Index added +1.18% in May and the S&P China500 Index gained +0.98%.


Property and Infrastructure

  • Property and infrastructure assets bounced back after a tough April.
  • Their inflation-linked revenues are coming back into favour as inflation remains sticky.
  • Australian Listed Property (A-REITs) gained +1.94%.
  • Global Listed Property (Hedged) added +2.92% whilst Global Listed Infrastructure (Hedged) increased +5.64%.


Fixed Income

  • The Bloomberg Australian Bond Index gained +0.60% in May.
  • The 10-year Australian government bond yield eased to 4.40% from 4.53% a month earlier.
  • The RBA maintained interest rates at 4.35% for a fourth consecutive meeting in early May.
  • All eyes will be on the RBA’s 18 June policy statement after the stronger-than-expected April CPI inflation print (released in late May).

 

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