Q1 Market Update

We have certainly enjoyed a better-than-expected rally in Q1 of 2024 across most asset classes as a  combination of solid company earnings results and no further expected interest rate hikes. This is on the back of Australia’s economy facing the same knock-on problem for the last couple of years as rest of the developed world: record high inflation, driven by high demand for goods meet with a low supply response.

Central banks around the world were forced into aggressively raising interest rates from their historically low levels to contain demand and pricing pressure – and to help restrict the self-fulfilling wage-price spiral that follows, in order to keep up with said high inflation.

The common theme of central banks through the second half of 2022 & all of 2023 had been “let’s not repeat the mistakes of the 1970s” where taking their foot of the accelerator too soon led to  higher-than-expected inflation for over a decade. Interest rates in most countries, including Australia, have been lifted to above their average levels for the last couple of decades. The aim has been to ensure inflation is brought under control in the first attempt and not requiring two bites at the cherry like in the 70’s; but, without over cooking it and forcing a global recession.

An economic ‘soft landing’: the runway is in sight

As we head into the second quarter of 2024, the news relating to diminishing potential of a recession back home is encouraging. Although economic growth has slowed in the last 12 months leading to a per capita GDP decline, it has proven more resilient than expected owing to 2 main factors – the record population growth that we have seen from new migration and low unemployment rates (just under 4%), thus avoiding a recession to this point. The resilience in economic activity has led to inflation being sticky and harder to bring down but it might be just what we need to avoid a recession. The March quarter saw a slight resurgence in inflation which means it is still higher than where the Reserve Bank would like it to be at under 3.00% per annum. The latest reading that we have from Australian Bureau of Statistics (ABS) is 3.60% year on year growth in inflation for the March quarter compared to 4.10% this time last year. It does however mark the fifth consecutive quarter of lower annual inflation since the peak of 7.80% in the December 2022 quarter.

This resilience coupled with the falling inflation has provided much confidence in investment markets with most major markets soaring since the last quarter of 2023. While Inflation is still too high, it is moving in the right direction and still nothing has broken, this gives a whole lot of weight to the old saying, ‘Don’t fight the FED’. It doesn’t seem to matter what happens – Geopolitical events, potential banking crisis, data reports that indicate a resurge in inflation; central banks have seemingly been able to find another lever to pull to sweep up the mess.

While economies appear to be under control, some risks remain. It would be remiss of me to suggest it is all smooth sailing. It’s still possible that the lagged impact of past interest rate increases catches up with the economy, especially as more households and businesses are forced to refinance cheap COVID loans at higher rates; And not to mention the US regional banks will be coming due to repay their liquidity duration blunder bail out. A more troublesome risk is if the excess demand for labour reduces but the decline in inflation slows, this could see a significant rise in unemployment as businesses try to save some costs. A final risk is geo-political – an escalation in the tragic conflicts in the Middle East and Europe that pushes up inflation through disruption of critical global food and energy supplies. Chinese tensions with Taiwan also persist.

Global growth and markets

Globally, things are looking positive as well from where we currently stand it looks like the Federal Reserve in America may have pulled off a soft landing similar to our Reserve Bank. In our pursuit to retrospectively analyse and comprehend recent economic data that we’ve seen coming from America, the historical outcomes that we may have compared it to in the recent past may end up being a poor guide. Comparing central bankers’ worst fears ‘inflation of the 1970s’, the nature of the inflation shocks differed. During the 1970s, the onset and return of high inflation was caused principally by two sharp oil price rises due to OPEC oil restrictions; this with combined with the fact that the manufacturing sector was still a driving force of economies, price pressures weren’t nearly as competitive due to high cost and restrictions of globalised markets lead to inflation to become more embedded in the US economy. The post-COVID inflation burst, by contrast, was largely due to a strong increase in demand relative to weak supply which was the unfortunate outcome of supply chain disruption caused by the lock downs. Inflation lifted, but demand remained strong which makes this an anomaly and now certainly appears to have been a series of one-off price level adjustments to clear markets suffering from the excess demand.

On the European Sub-Continent, the European Central Bank (ECB)has maintained interest rates at their record-high levels at its April meeting. The ECB said it may consider reducing the level of policy restriction, if it becomes more confident that inflation is moving steadily toward the 2% target. We expect them to look west and follow the Fed’ stance with keeping rates higher for longer.

In China, policy stimulus and increase in government infrastructure investment have given an early boost to growth prospects for 2024. March data shows us that industrial output and retail sales are yet to gain momentum, but the effects of said stimulus can often lag by almost 12 to 24 months. This does present a compelling case for us to continue investing in emerging markets and make the most of recent Chinese equities underperformance. Across emerging markets, we also see India as having favourable investment prospects. GDP is consistently rising faster than population growth, and since the Covid reopening, net foreign direct investment as a share of GDP has been three times higher in India than in China. Fifteen years ago, flows into China were sometimes four times larger than into India. We take a core indexed approach to investing in India along with an active approach to investing in China, Taiwan, South Korea, and other countries in the Asian subcontinent.

Concluding Remarks

As mentioned, financial markets have roared into 2024 with most major markets boasting great figures, the S&P reached an all-time high in February and is trading just couple of per cent below it at the moment. Bond yields have stabilised as well with small bouts of volatility every time inflation re-surges but presenting a lucrative long-term investment opportunity especially once interest rate cuts are in effect. Historic trends show if we have a positive start to a year, we tend to see a positive year ahead, and most major markets seem to be holding true to the trend.

Against this backdrop, the outcome for 2024 appears to be positive but there will be further slowing in growth, which should allow for further declines in inflation leading to expectation of central bank interest rate cuts within the next 12 months. Lower rates would then allow a stabilisation in growth and moderate recovery in 2025.

Such an outcome could be favourable to both bond and equity markets this year. High but falling bond yields should make for decent income and also capital returns from fixed-income markets as investors drive up bond prices as they look to lock in those higher yields on longer duration bonds. Lower bond yields could also support equity valuations at least holding around current levels, while allowing dividends and growth in earnings to deliver positive returns for investors.

Easing global recession risks and interest rate cuts from the US Federal Reserve should favour a weaker US dollar and firm up the Australian dollar. A weaker US dollar, lower bond yields and improving global growth prospects later this year could also be positive for commodity markets, especially Gold as the metal is dollar-denominate, meaning a stronger US dollar tends to keep the price of gold lower and more controlled, while a weaker US dollar is likely to drive the price of gold higher through increasing demand.

We also expect to see continued momentum of growth in themes such as generative AI & battery technology leading to new innovation leaders in this space. We continue to invest in such themes for our clients using thematic Exchange-Traded Funds (ETFs).

Please reach out to your financial adviser to organize a meeting if you have any questions, concerns or require specific financial advice relating to any of the information mentioned in this newsletter.