november
2024

Market Update

EXECUTIVE SUMMARY

  • The US Q3 earnings season has delivered mixed results.
  • Resilient consumer spending, lower inflation and lower interest rates provide hope for broadening earnings growth beyond mega-cap US technology companies.
  • The technology sector is boosting AI investments, but its future earnings potential remains unclear.
  • Warren Buffett’s Berkshire Hathaway continues playing defence, further reducing equity market exposure.
  • Investor sentiment remains bullish as investors focus on the positives.
  • In the short term, markets must navigate through the 5th November US elections.

MARKET SUMMARY

US and Australian equity markets eased in October, ending a five-month winning streak that had propelled markets to record highs. Bond markets declined and yields rose as investors dialed back expectations for substantial rate cuts.

October marked the start of the US Q3 earnings season. As always, outlook statements mattered most as investors sought to determine if analysts’ future earnings forecasts were attainable.

The table below shows the mixed performance of the largest US companies throughout the earnings season.

Big Banks performed well.

Earnings season started positively, with large US banks such as JPMorgan, Bank of America, Citigroup and Goldman Sachs all beating quarterly earnings expectations. Their investment banking and wealth management divisions benefited from buoyant capital markets and solid merger and acquisition activity. Global banking stocks have been standout performers this year.

The US consumer continues to spend.

Bank executives spoke about the continued bifurcation of the US consumer, where high—and moderate-income (and asset-rich) consumers are still spending a lot, and low-income consumers are under pressure.

If employment holds up, people feel secure in their jobs, and wages grow faster than inflation, the consumer will continue spending, which is good for the economy. Citicorp commented, “Consumers are broadly healthy and resilient but more cautious”. Bank of America noted, “Consumers are wary of the cost of living, worried about higher rates and other matters….but overall, activity is fine”.

Beverages giant Coca-Cola agreed, adding, “…there’s a lot of variables out there that are still uncertain, but at the root of it all, [consumers] continue to spend.” Global payments giant Visa also spoke of US consumer resilience “Consumer spend across all segments from low to high spend has remained relatively stable.”

Broadening earnings growth?

A key hope entering earnings season was broadening earnings growth beyond mega-cap technology companies. Cyclical companies, whose prospects are closely linked to the economy’s trajectory, are expected to benefit from ongoing economic growth, easing inflation and lower interest rates.

On the positive side, many companies discussed a “bottom” in the business cycle, which may signal an inflection point for cyclical company earnings.

However, there’s still much uncertainty about the magnitude and durability of any earnings recovery. For example, Caterpillar, the world’s largest construction and mining equipment manufacturer, has downgraded its revenue outlook, citing uncertainty surrounding the US election and ongoing growth issues in China.

Big technology reported ok.

Strong demand for cloud services aligned with the Artificial Intelligence (AI) boom was again the primary driver. Alphabet reported an impressive 35% lift in Google Cloud revenue from a year ago, ahead of Microsoft’s 33% increase in Azure and Amazon Web Services’ 19% growth.

Microsoft provided some details about its AI business, stating that its current annualised revenue is relatively small, at approximately US$10 billion. This accounts for approximately 4% of total revenue, and it is expected to rise as software products like CoPilot see greater adoption.

Dwarfing this number, mega-cap companies continue to individually spend US$10 billion-plus per quarter on AI-related infrastructure (e.g. data centres and servers). On monetisation, there is still little visibility over future demand or earnings uplift.

But this is not dampening their enthusiasm. Take Amazon CEO Andy Jassy, who commented on the company’s plans to spend US$75 billion on capex in 2024: “It is a really unusually large, maybe once-in-a-lifetime opportunity  We feel good about this long term, that we’re aggressively pursuing it.”

Tesla CEO Elon Musk was as upbeat as ever, “Tesla is focussed on the future of energy, transport, robotics and AI…if we execute on our objectives, and I think we will, my prediction is Tesla will become the most valuable company in the world, probably by a long shot”.

Berkshire is still playing defence.

Finally, Warren Buett-led Berkshire Hathaway’s recent financial report shows it has sold US$133.2 billion of equity securities over the past nine months, compared to just US$5.8 billion of purchases. Berkshire’s equity holdings now represent less than half of its investment portfolio.

Berkshire favours low-risk, short-dated US Treasuries as it waits for better value to emerge in equities.

What is the Consensus View?

Finally, Warren Buett-led Berkshire Hathaway’s recent financial report shows it has sold US$133.2 billion of equity securities over the past nine months, compared to just US$5.8 billion of purchases. Berkshire’s equity holdings now represent less than half of its investment portfolio.

Berkshire favours low-risk, short-dated US Treasuries as it waits for better value to emerge in equities.

China's stimulus is a reason for optimism.

  • Deflationary pressures coupled with structural slowdown concerns saw Chinese officials take actions talking up their stimulatory plans.
  • The actions include interest rate cuts, lowering reserve requirements and making central bank funding available to investors.
  • Each of these measures are powerful, unleashing them all together is unusual and shows the commitment from Beijing to boost investor confidence.
  • Despite an initial boost to investor confidence, a lack of clarity continues to weigh on investor confidence as seen in both Chinese equity and bond markets.
  • Analysts remain divided on the amount of stimulus needed in China to ease the structural challenges and meet their 5% growth target.
  • A key point of interest for us is the cost to funding a stimulus program in China relative to the cost in developed nations like the US.
  • The current cost of borrowing by the Chinese government is 2.30% over 30-years vs 4.39% in the US.
  • The volatility in the above chart since the stimulus announcements highlights the uncertainty the bond market has in the next steps…China can do more but is it going to do more?

US Earnings are about to take off!

  • US corporate earnings (and expectations of future earnings) are once again under the spotlight as September quarter reporting season heats up.
  • Despite it still being early days, expectations are for corporates in the US to grow profits in the 15-20% region over the next 12-months (orange bars left chart below).
  • What will drive this profit growth?
  • With a strong labour market, we know profit growth is unlikely to come from cost cutting (layoffs).
  • With a strong labour market/consumer coupled with a supportive US Fed, profit growth may once again come from higher selling prices and/or more units/volumes being sold. (Positive for equities)
  • According to Factset, US S&P500 Earnings growth for the September quarter is expected to be 4%. Most corporates “beat” expectations so actual 12-month earnings growth could be around 7%.
  • As we can see in the valuation chart below, these optimistic earnings need to be achieved to merely justify current pricing on the US S&P500 Index (orange bars right chart below).

Potential Risks to the Consensus View?

A monetary policy mistake.

  • The timing and size of future rate cuts is a dicult task, one which is easiest done in hindsight.
  • The US Fed was criticized for being slow off the mark, but strong labour market data over the last month suggests their choice of a 0.50% rate cut over a 0.25% may have been an error.
  • The counter argument from some is the initial rate cuts are merely a reversal of an aggressive interest rate hiking cycle and would therefore not be as stimulatory in nature.
  • The diverging growth paths of the manufacturing sector and services sector also complicates
  • The US manufacturing sector has been contracting for the last 22 months whilst the US services sector continues to expand albeit at a slower pace more recently.
  • Policy decision making is fraught with danger and comes with flashbacks of taming the inflation dragon.
  • Whilst there may not be a financial accident, there is likely to be volatility.

Israel-Iran conflict escalates.

  • The continued escalation in conflict in and around Israel has the potential to disrupt global energy markets.
  • Oil supply disruption is not the base case priced in by oil traders with Crude Oil currently trading below levels seen when Russia invaded Ukraine in Feb22 and the first attack on Israel in Oct23.
  • A move in oil prices from the current $69 to the $80 mark is likely to grab some investor attention and potentially pressure equities downward as investors seek risk premium again.
  • The gold market perhaps tells a more cautionary tale about the tit for tat ladder of escalation being climbed by leaders in Israel and Iran.
  • The initial strength in gold was on news of emerging market Central Banks buying gold (2022), this was followed by interest rate cut expectations (2023).
  • More recently Gold remains bid up with the key driver now being geopolitical uncertainty.
  • Equity investors are optimists, often discounting the risks of large-scale conflict until it’s highly probable.

A Contested US Election result.

  • The 2024 US election remains a tight race and knowing with certainty who will occupy the Oval Office on 20 January 2025 (inauguration) is still too close to call.
  • The biggest risk to markets is not as much who ends up in the oval, but the risk of a contested/ drawn out election result.
  • The lack of clarity resulting in legal battles which take time to resolve is likely to dampen equity market prices in the short term.
  • Whilst this is a risk to markets, the headlines are likely to be temporary and present a buying opportunity for long-term investors.

 

Long Term Investment Objectives Is Key

  • There will always be a bullish and a bearish case to investing.
  • This no truer than in the world of highly liquid share market investing.
  • Over the long-term the trend is very much in the favour of investors.
  • Over the short- and medium-term investor behaviour however impacts returns, in a good or a bad way.
  • With asset prices high and attractive investment opportunities limited, discipline is key.
  • Important to us is the awareness that consensus thinking is bullish, and the level of optimism is elevated.
  • Optimism is eventually replaced by pessimism, and this is likely to be the case again in the future.

ASSET CLASS PERFORMANCE

Australian Equities

  • The S&P/ASX200 Index slipped -1.31% in October, its first monthly loss since April.
  • Only 3 of 11 sectors gained during October, led by Financials +3.25%. Australia’s big banks are expected to announce improving profitability and increased dividends when they report in early November.
  • Healthcare +0.89% and Communications +0.75% also advanced.
  • Utilities -7.23% performed worst as bond yields climbed (making debt more expensive and weighing on valuations). Compounding matters was UniSuper offloading a $500M line in Australian energy infrastructure business, APA Group, at a sizeable discount to market. APA declined -10.2% for the month.
  • Consumer Staples -6.99% was the next worst performing as Woolworths slumped -10.0% after it cut full-year earnings guidance on a weaker-than-expected margins outlook.

 

International Equities

  • The MSCI All-World Index declined -1.98% in October.
  • On US markets, the technology-heavy Nasdaq eased -0.49%, the S&P 500 Index -0.91% and the Dow Jones Industrials Average -1.26%.
  • European equity market returns (measured in USD) underperformed partly due to a weakening Euro curren- cy. The S&P Europe 350 Index fell -5.68%. In October, the European Central Bank cut interest rates by 0.25% for a third consecutive meeting as sluggish growth and weaker inflation persist.
  • Weakness in Japanese equities (measured in USD) also reflected a weaker Yen, with the S&P Japan 500 Index declining -5.37%. The Japanese economy has hit a soft patch as stubbornly high prices and ongoing economic weakness weigh on sentiment. The services sector PMI recorded its worst reading since February 2022.
  • Emerging market equities retreated after September’s massive rally. The Dow Jones Emerging Market Index eased -3.82% in October, and the S&P China500 Index lost -4.62%.

 

Property and Infrastructure

  • Interest rate-sensitive asset classes were pressured by higher bond yields as markets priced in a shallower easing cycle.
  • Australian Property declined -2.51% and International Property -4.98%.
  • International Infrastructure +0.46% fared better.

 

Fixed Income

  • The Bloomberg Australian Bond Index declined -1.88% in
  • The 10-year Australian government bond yield surged 55 basis points (0.55%) to 4.51% in September.
  • Higher US bond yields, a strong domestic jobs market and stubborn inflation have delayed hopes of Australian interest rate relief into the second quarter of 2025 (based on current market pricing).