Higher for Longer
Much of the support for equities over the year has been driven by the equity market’s belief that the ‘terminal rate’ for this cycle of interest rates has been reached, and that the central banks would start cutting rates as soon as the end of this year. Contributing to this narrative was data showing inflation continuing to decline and a better-than-expected earnings season.
However, as the end of quarter approached, stocks came off their highs and bond yields continued to rise as both the Federal Reserve in the US and the RBA emphasised that rates would remain higher for longer. The message is now coming in loud and clear that the central banks are not planning on a rapid policy pivot as many were expecting.
The Australian stock market is up 13.5 per cent for the previous 12 months, but much of that performance came from the last quarter of last year and the first quarter of this year. In the September quarter, the ASX 200 Index is down by nearly 1 per cent. The IT sector is down by nearly 6 per cent for the quarter as the expectation of higher rates affects the growth stocks.
Developed Markets are up 17 per cent for the 12 months, driven by the large US technology stocks. But as the “higher for longer” narrative takes hold, these technology stocks have borne the brunt of selling, with the S&P 500 Information Technology Index down by more than 10 per cent from its July high.
For bond investors, the pain is likely to continue as traders are expecting further yield increases as the “higher for longer” message seeps in. Complicating the global fight against inflation is the unwelcome surge in oil prices, and the fact that economies remain resilient.
Against the backdrop of continued rate increases, the bond market continues to signal that the US will end up in recession, along with the Eurozone, which will also markedly slow Australia’s economic activity. China’s economic slowdown after the post-pandemic rebound is also contributing to the gloom about next year’s prospects.
However, as we have seen throughout the year, economic predictions have very little bearing on what markets will do over the next quarter, or the next year.
Market Overview
- Despite the fastest rate rises in a generation, equity markets have rallied over the last 12 months, even though much of the performance has been driven by a handful of large tech stocks in the US on hype around artificial intelligence.
- That support has fallen away in the last few weeks of the quarter, as central banks see rates staying higher for longer and flagging consumer confidence triggering a sell-off, with tech stocks falling by more than 10 per cent.
- Most equity markets have now fallen back to levels seen at the start of the quarter.
- Inflation remains sticky and even resurgent, thanks in part to a 30 per cent rise in oil prices since late June, which has seen bond yields continue to rise on the expectation of more rate rises ahead.
- However, the higher income from bonds is off setting the rise in yields, and bonds have delivered positive returns over the last 12 months.
- Emerging Markets continue to lag developed markets, principally because of the poor performance of China and the effect of a strong US dollar.
- REITs are now more correlated to the broader risk market than has been the case since the pandemic.
Australian Factors
Factors are very volatile over short time periods. Looking over the course of the last 12 months, value stocks out-performed growth stocks by 9.5 per cent, as lower relative price companies on average did better than higher relative price companies. However, smaller companies continue to under-perform the broader market.
Global Factors
The global markets are dominated by the US, which accounts for approximately 70% of the MSCI World Index. The biggest driver of US returns in the last year has been the large growth tech stocks, resulting in value and small cap stocks underperforming the broader market. However, the MSCI World ex-USA index has delivered a value premium.
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