September
2024
Market Update

EXECUTIVE SUMMARY

  • Markets were rattled by US growth concerns in early August but quickly recovered as economic data stabilised.
  • The Australian profit reporting season was mixed with solid dividends but generally cautious outlook statements.
  • Australian share prices appear to have run ahead of fundamentals, making them vulnerable to a change in investor sentiment.
  • Higher iron ore prices or earlier RBA interest rate cuts would boost the Australian earnings outlook.

MARKET SUMMARY

August was an eventful month for investors. A US growth scare sparked an initial selloff, but markets quickly recovered as stronger economic data soothed recession concerns.

Most of Australia’s leading companies reported profit results in August and provided outlook guidance.
The profit season highlighted the disconnect between rising Australian share prices and softening earnings.
Aggregate ASX200 profits declined marginally for a second consecutive year amid subdued consumer spending, higher costs and weaker commodity prices. Against this backdrop, the ASX200’s +15% return over the past 12 months seems misplaced.

Individual company results and share price reactions were mixed, as shown in the table below.

The message on consumer spending was soft, with sales generally down. Well-known retail names including JB HiFi, Woolworths and Coles, have navigated this period well, managing cost pressures across their businesses.

Companies including AGL Energy, Origin Energy, Telstra and Transurban noted higher demand for hardship support due to cost-of-living pressures.

Higher listings at CAR Group (owner of CarSales) and REA Group (owner of realestate.com.au) are another sign of consumer stress, indicating a level of forced sales.

Seek described a weakening jobs market as more people seek work despite fewer job ads.

Various industrial and building materials companies noted subdued conditions in the housing sector. James Hardie reported a reduction in Asia Pacific Fiber Cement volumes driven by “weak demand in Australia”. Plumbing supplier Reece noted it is enduring a “softening housing market” that is “expected to remain soft”. Wesfarmers added that Bunnings sales have moderated in the first six weeks of the new financial year due to “continued market

-wide softening in building activity”.

Big bank results were respectable and generally well-received by the market as net interest margins stabilised. CBA reported that 90-day mortgage arrears had risen in line with historical averages. NAB noted “higher arrears for the Australian mortgage portfolio” and said business borrowers also feel stressed with “a continued broad-based deterioration in the Business & Private Banking business lending portfolio”.

Rising debt costs hit rail freight operator Aurizon and property groups Dexus and GPT as Australian interest rates remain higher-for-longer. Aurizon’s interest on drawn debt increased to 6.2% from 4.1% a year earlier.

Overall earnings guidance was cautious, leading analysts to trim their 2024-25 ASX200 earnings growth expectations to 3% (from 5%). This compares to about 17% forecast earnings growth for the US S&P500 Index.

The materials and financials sectors are most important for Australian investors, comprising about half of the market’s value.

Iron ore prices are the biggest driver of materials sector profits. They can be unpredictable, but they are expected to weaken further due to softer Chinese demand and increasing global supply. BHP’s recent results deck shows that a US$10/t change in the iron ore price impacts underlying earnings by about 8%, which is highly significant.

Australia’s major banks are an excellent example of where subdued profit growth hasn’t stopped share prices from rallying. CBA is the world’s most expensive listed bank, trading on about 23 times earnings compared to the global peer average of about 12 times.

The bears believe that elevated Australian valuations and limited growth prospects leave the equity market vulnerable to a change in sentiment. The bulls point to the recent V-shaped recovery as evidence that the overall market trend remains bullish. Indeed, investors are still buying the dip rather than selling the rallies. The bulls hope for an upside surprise from commodity prices or sooner-than-expected interest rate relief to reignite earnings growth. Regardless of who is correct, we believe Australian equities remain important diversifiers and sources of income for multi-asset portfolios.
The volatility spike was short-lived.
  • It was a volatile start to August, with global equity markets down 5 – 8% in the first few days before fully recovering these losses.
  • We recently wrote that “Investor confidence is all that matters”, noting that earnings multiple expansion (not earnings themselves) had driven equity market gains over the past 12 months.
  • Investors seemed confident that earnings would surge higher and justify current prices. While this bullish sentiment persisted, any ‘bad’ news was quickly spun into a positive.
  • Recent market volatility indicates investors are again paying attention to some of the negatives.
  • For example, over the past few months softer US jobs market data has been viewed as positive, suggesting that interest rate cuts are coming. However, this same data now has a negative read-through (a recession may be coming).
  • Investors were also rattled by a sharp fall in the Japanese equity market.
  • Wall Street’s VIX Volatility (Fear) Index briefly spiked to 65, a level only surpassed by the 2008 Global Financial Crisis and the 2020 pandemic.
What’s making investors nervous?
Weak US economic data/recession fears.
  • Investors have marvelled at the US economy’s resilience to elevated interest rates over the past 12 months.
  • This has seen the emergence of a “no landing” scenario in which US economic momentum continues, seemingly unaffected by higher interest rates.
  • Some weak economic data saw the “hard landing” or recession scenario return to the conversation as investors worried that the US Fed would cut rates too late (to cushion the economy from a downturn).
  • As of 2 September, markets had priced in a:
    • 100% probability of a 0.25% rate cut and a 31% probability of a 0.50% rate cut in September.
    • 70% probability of at least 1.00% of rate cuts by December.
  • Historically, equity markets have sold off as interest rates have been aggressively cut (red circles below) because a weakening economy is bad for employment, consumer spending and ultimately earnings.
  • This is what has the equity market bulls on edge.
Elevated US technology stock valuations.
  • US mega-cap technology stocks have been the primary driver of capital growth for global investors over the past two decades.
  • In the most recent financial year, the ‘Magnificent 7’ drove 55% of the US S&P500’s return.
  • There is a lot of hype surrounding artificial intelligence (AI), which has driven up the valuations of technology companies.
  • Investors are now asking when they will start reaping the benefits of their substantial investments in AI.
  • The short answer is not for another year or two, as most companies are still in the piloting phase.
  • But sooner or later, big tech will have to show that AI can make real money.
  • Going forward, there is potential for AI disappointment to deflate technology sector valuations and weigh on US and global market returns.
  • The technology sector is by far the largest sector, accounting for 30% of US and 26% of global index funds.
 
The Yen carry trade.
  • Inflation in Japan has been very low for decades, which has allowed interest rates to remain extremely low.
  • Such persistently low interest rates created an opportunity for global institutional investors (e.g. hedge funds and banks) to borrow large sums in yen and invest the proceeds offshore.
  • The idea was to pay a small amount of interest in Japan and generate a higher return offshore.
  • For example, if an investor borrows $1 million worth of yen at an interest rate of zero and invests in a US dollar bank account earning 4%, that should earn them a 4% carry.
  • This is known as the ‘carry trade’.
  • In addition to the favourable interest rate differential, a generally weaker Yen over time has made it cheaper to repay the Yen-denominated debt.
  • Market forces are now moving in the opposite direction.
  • The Bank of Japan unexpectedly increased interest rates on 31 July, and the US Fed is expected to com- mence cutting US rates shortly.
  • The Yen is now strengthening (red oval below).
  • The concern is that if all investors rush for the exits at the same time, it could lead to a disorderly unwind of risk assets.

ASSET CLASS PERFORMANCE

Australian Equities
  • The S&P/ASX200 Index recovered strongly from an initial -5.73% sell-off to end August +0.47% higher.
  • At a sector level, Technology +7.86% performed best thanks to a +25% surge in logistics software provider WiseTech Global (ASX: WTC) shares. WTC signalled more growth ahead as it launched three new products to support new and existing customer adoption.
  • Industrials +3.52% performed next best, boosted by a +17% rally in Brambles (ASX: BXB) shares after it reported better-than-expected margins and profit from its North American pallets business.
  • Energy -6.73% performed worst, as Santos (ASX: STO) –9.64%, Ampol (ASX: ALD) -13.56% and Whitehaven Coal (ASX: WHC) -13.34% fell.
 
International Equities
  • The MSCI All-World Index added +2.64% in July and has gained +24.23% in the past 12 months.
  • For a second consecutive month, US technology stocks lagged. The Nasdaq’s +0.74% gain was bettered by the Dow Jones Industrials Average +2.03% and S&P 500 +2.43%.
  • European stocks rose to an all-time high in August after a significant drop in inflation cemented market expectations for an interest rate cut in September. The S&P Europe 350 Index gained +3.79%.
  • Japanese equities were at the epicentre of market volatility in early August, slumping -12.4% on 5 August only to bounce back +10.2% the following day. The sell-off was exacerbated by a sharp rally in the Japanese yen, which is believed to have triggered a scramble to close out carry trades. The S&P Japan500 Index ended the month +2.39% higher.
  • The Dow Jones Emerging Market Index added +1.94% in August, whilst the S&P China500 Index eased -0.40%.
 
Property and Infrastructure
  • Interest rate-sensitive asset classes performed well as the case for lower US interest rates solidified.
  • US Fed Chair Powell confirmed that “The time has come for policy to adjust” at the Jackson Hole Symposium. He expressed confidence that inflation was on a sustainable path to 2%, adding that further cooling in the labour market would be “unwelcome”.
  • International Property and International Infrastructure gained +5.70% and +3.38%, respectively.
  • Australian Property crept +0.54% ahead as Goodman Group (ASX: GMG, 37% of the Index) declined -4.84%.
 
Fixed Income
  • The Bloomberg Australian Bond Index gained +3.28% in August.
  • The 10-year Australian government bond yield eased to 3.97% from 4.14% a month earlier.
  • Australian bond yields are moving in sympathy with lower US and global bond yields despite the RBA warning that Australian rates will not be cut this year.