Monthly Investment Update — September 2022
We are pleased to present you with September’s client newsletter.
The main points are as follows:
After rallying in July, markets have now reversed course downwards.
The initial rally was prompted by expectations that central banks may not be so aggressive raising interest rates.
However, these expectations were premature as global central banks reasserted their intentions.
Central banks WILL fight inflation and growth WILL slow.
Analysts have downgraded earnings growth expectations and so too are business managers concerned.
Now is a time to seriously think about protecting money in priority to growing money.
The S&P500 Index continued its July rally gaining another +4.23% by mid-August. The bulls however handed the baton to the bears in the second half of the month seeing the Index end the month -4.24% lower.
One driver behind the recent rally was investors’ misinterpreta$on of US Fed Chairman Jerome Powell’s “neutral rate” comments. Investor expectations was for a more modest interest rate hike path. Several US Fed committee members however reminded investors the job is not done yet and their focus remains on killing inflation.
Investors eventually listened with the turning point being 16th August when the minutes from the 27th July US Fed meeting was released. The minutes has the word “Inflation” men$oned 108 $mes whilst the word “growth” was men$oned 32 $mes. Clear to everyone is infla$on will be brought back to target even if economic growth slows.
This message was further reinforced when Jerome Powell spoke from Jackson Hole. The opening line of his speech had most investors sit up and pay attention. “Today, my remarks will be shorter, my focus narrower, and my message more direct”. There will be no room for misinterpretation is what Jerome Powell means.
“Restoring price stability will take some time and requires using our tools forcefully to bring demand and supply into better balance. Reducing inflation is likely to require a sustained period of below-trend growth. Moreover, there will very likely be some softening of labour market conditions. While higher interest rates, slower growth, and so"er labour market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.”
This is the message the US Fed Chair shared with the world. Inflation is a problem and must be solved even if it brings some pain to households and businesses. Now is a time to protect money. A $me will come when inflation will be much lower and the US Fed more supportive of growth. That time is not now.
We remain cautious in how we allocate money and encourage clients to do the same. The extent of the economic slowdown remains unknown with the fallout from the European energy crises an added complexity. We remain focussed on portfolio resilience ensuring portfolios are diversified, of high quality, and highly liquid.
ANALYSTS LOWER THEIR US EARNINGS EXPECTATIONS
After the latest reporting season, the headlines in financial media read “Better Than Expected Earnings”. We are however more interested in knowing what “expected” was and is.
Below is a comparison of corporate earnings Expectations in February vs Expectations today.
The latest reporting season may have seen earnings come in “Better Than Expected”, but expectations have been lowered. The headline should read “Earnings Missed Earlier Expectations”…by -2.5%.
So too have analysts downgraded earnings estimates for Sep22, Dec22, and Mar23. They Can’t downgrade Jun23 earnings as the forward earning multiple will be markedly higher and that is not good.
The S&P 500 Index is currently trading on 20-times current earnings multiple. Very, VERY generous given the high levels of uncertainty. If you believe in forward earnings estimates, that is 18.5 times which is still generous.
BUSINESS MANAGERS ARE WORRIED ABOUT SLOWING GROWTH
Wall Street analysts are downgrading their own future earnings expectations as seen above. So too are business managers turning more cautious around their business outlook (monthly PMI surveys).
The weakness is broad and seen across both the US Services and US Manufacturing sectors. The key reasons cited are higher interest rates and high levels of inflation.
The growth outlook today is very similar to 2019 when the US Fed moved to cut interest rates and save growth from turning negative.
This time the US Fed continues to raise interest rates despite this survey flagging a US services sector recession in the coming months.
The market is currently betting on so landing/goldilocks. A setup where inflation is falling (likely) and
growth is stable (unlikely). Recession risks, therefore, remain highly elevated in our opinion.
GOOD NEWS! INFLATION DATA CAME IN BETTER THAN EXPECTED
Inflation is the single biggest economic data point these days. The US Fed, investors, and consumer all tune in to get the latest monthly read.
Annual CPI for July was 8.5% which was better than the 8.7% expected and lower than June’s print of 9.1%.
Most important to us is how the US Fed interprets the data as that provides a clue in how they are likely to respond (or in eloquent Wall Street speak, the reac$on function of the Fed).
The US Fed is focussed on the momentum (what did prices do in the most recent of months) and breadth of inflation (in how many categories is inflation elevated).
Monthly inflation less food and energy was 0.31% in July (3.72% annualised). The 6-month average is 0.51% (6.12% annualised). Monthly momentum is still strong, running well above pre-pandemic levels.
The breadth of inflation is not encouraging either. When we add the more volatile food and energy costs, monthly inflation is 0%. The fall in energy costs offset the rise in prices in just about every other category.
The continued rise in prices in the services part of the basket is concerning. Bringing down infla$on in areas such as shelter is much more difficult than energy.
We would highlight that the future direction of energy prices remains uncertain. A continuation of the latest outcome should not be taken as a given.
AUSTRALIAN EQUITIES
The S&P/ASX200 Index gained +1.18% over the month of August. The local market continues to outperform international Equities over a 12-month timeframe. Supporting the local market is a strong 12-month performance from the Energy sector (+47.72%) and Utilities sector (+29.21%).
As interest rate expectations shied higher the market reversed the sector strength from a month earlier. Leading the market lower was listed Real Estate (-4.21%), Consumer Staples (-2.65%) and Utilities (-1.61%).
The strength was once again seen in the Energy and Materials sectors which gained +7.42% and +3.90% respectively.
INTERNATIONAL EQUITIES
The MSCI All World Index ended the month -4.18% weaker increasing the 12-month drawdown to -15.08%.
Leading the weakness was the S&P Europe350 Index (-6.18%), followed by the US S&P500 Index (-4.08%) and the S&P Japan500 Index (-2.90%).
Emerging markets outperformed its developed market peers gaining +1.46% over the month despite the Chinese market ending the month -2.08% lower.
PROPERTY AND INFRASTRUCTURE
Australian Property Index gave back some of last month’s gains ending the month -3.55% lower. Global Listed Property (Hedged) ended the month -5.45% lower, a clear underperformer over a 12-month timeframe.
Global Listed Infrastructure (Hedged) remained largely flat (-0.49%) over the month and remains the top performing asset class over a 12-month timeframe gaining +12.36%.
The relative strength of infrastructure assets over the last 12-months highlights to us just how popular this asset class has become with investors.
FIXED INCOME
The Bloomberg Australian Bond Index declined -2.54% over the month as investors price in higher interest rate expectations. The widely followed Australian bond index is down -11.50% over the past 12-months.
The monthly performance of equities and bonds remain highly correlated. Whilst this is unusual, it is expected during times of stagflation.
The 10-year Australian government bond yield closed the month at +3.63%. The higher this risk-free rate goes, the less attractive other asset classes become.
GENERAL ADVICE WARNING
The advice contained within this document does not consider any person’s particular objectives, needs or financial situation. Before making a decision regarding the acquisition or disposal of a Financial Product, persons should assess whether the advice is appropriate to their objectives, needs or financial situation. Persons may wish to make their assessment themselves or seek the help of an adviser. No responsibility is taken for persons acting on the information within this document. Persons doing so, do so at their own risk. Before acquiring a financial product, a person should obtain a Product Disclosure Statement (PDS) relating to that product and consider the contents of the PDS before making a decision about whether to acquire the product.