Market Update: May 2022
June was a horror show for investment markets, with all major markets and asset classes down. The Australian market lost 9% to extend the drops in May and remain 10% down for the year. Global stocks and the US market both fell 8% and the only market which showed any strength was China, finishing the month up 10%, however still remains 10% down for the year. We summarise the performance of key markets below.
|1m||3m||6m||1yr||3yr (p.a.)||5yr (p.a.)|
|Australian Listed Property||-10.39%||-17.49%||-23.03%||11.22%||-1.95%||-4.96%|
|US Shares (USD)||-8.39%||-16.45%||-20.58%||-11.92%||8.77%||9.33%|
|World Shares (Hedged)||-8.10%||-15.10%||-19.37%||-12.61%||6.36%||7.33%|
As is obvious above, the first half of the year has concluded with another challenging month in June as inflation and recession fears continue to erode investor risk sentiment worldwide. The net result has been poor investment returns over the last financial year for most listed assets as can be seen in the next chart.
Source: Bloomberg, AMP
We can see from the above that the last 12 months (green bars) have been in stark contrast to the preceding 12 months (red bars) with only direct assets (residential property and infrastructure) being positive and all other classes well in the negative.
As recession fears heighten and inflation pressure heats up around the globe, central banks continue to be challenged by their now delicate mandate of interest rate settings. Expectations of further rate hikes have continued to gather steam. It is interesting to now see that markets are expecting Australian interest rates to be the highest in the developed world by mid-2023.
As can be seen above, the market is pricing substantial rate hikes well into next year. Looking at interest rate futures, the implied Australian cash rate after the RBA’s December meeting sits beyond 3.50%. This requires aggressive interest rate moves over the next few months.
|2022 RBA Meeting||Current cash rate||2 August 2022||6 September 2022||4 October 2022||1 November 2022||6 December 2022|
Source: Bloomberg & Van Eck as at 19 June 2022
The yields on Australian 10 year government bonds have gone even further, moving beyond 4%.
Chart 1: Australian Government Bond 10-year yield
Source: Bloomberg & Van Eck, 20 June 2022
These moves have been bad news for fixed income investors, which typically benefit from share market volatility. In what has been a case of ‘nowhere to hide’ the traditionally safe bond markets have also lost around 10% for the current calendar year. The market may have oversold longer dated bonds, and this presents an interesting trade opportunity if it has.
Looking forward, all eyes are turning to Europe which continues to face a gas crisis heading into the cooler months. Below shows natural gas futures contract prices, a key benchmark in Europe.
The Russian pipeline into Europe, supplying 40% of total supply, has just gone into its annual two week shutdown, further restricting supply and disrupting markets.
There are growing concerns that it will not resume operations after this, which would spell disaster for gas supplies across the continent.
There is a little good news being reflected in today’s markets. However, the significant de-rating in equity markets means that valuations are well below the long-run averages in most markets. There are however signs that US core inflation and wage growth may have peaked, and with falling work backlogs, freight rates, metal & grain prices, these are positive signs to ease the pressures on central banks to slow rate hikes.
In Australia, low consumer confidence and falling home prices indicate monetary tightening is already starting to get traction reflecting higher household debt levels and that the tightening started last year with rising fixed rates as the RBA ended its yield target. This in turn is likely to limit how much the RBA needs to, and will, raise rates to well below the 3.8% plus cash rate that the futures market has factored in
This means potential upside for long-term investors. While there are undoubted risks to both the economic and market outlook, markets have already fallen a long way in 2022. This does not imply that the trough has passed, and we should remain cautious with our approach and not attempt drastic asset class movements in a volatile market where few professional investors are able to do so (and none with consistency). Therefore, we currently think that maintaining a defensive/neutral allocation to risk assets while adding further to fixed interest positions is a more prudent approach.