We have passed the halfway point in 2024. The tightening of monetary policy in Australia has resulted in varied effects across different sectors. Households, particularly those with mortgages, are experiencing significant impacts due to higher interest rates, which have reduced their purchasing power and increased debt servicing costs. This financial strain has led to declining consumption growth, especially among low-income households. Despite these challenges, many households continue to service their debts on schedule, thanks to the resilience of the labour market. In contrast, larger businesses have benefitted from favourable wholesale funding conditions, while smaller businesses and those with higher leverage are facing more financial pressure. The market expects that business investment will soon slow down, although business debt growth is still above average even though borrowing costs have increased.
The broader implications of restrictive financial conditions include higher interest rates, incentivising households to save more and borrow less, leading to a decline in household credit growth. This is evident in various indicators, such as loan-to-value ratios and discharges to loan commitments. For businesses, the higher cost of debt is partly offset by strong nominal earnings and low leverage, although financial stress indicators show increased insolvencies, particularly among small businesses in construction and hospitality. Overall, these conditions are helping to balance demand with supply and contribute to declining inflation, which is essential for economic stability. The Reserve Bank of Australia (RBA) continues to monitor and adjust policies to ensure effective monetary policy, maintaining a cautious approach as it navigates the path towards economic stability.
“I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.”
– Warren Buffett
From a global perspective, 2024 is shaping up to be a significant year of elections, with Vladimir Putin’s exacerbating the Ukrainian conflict and increasing fears among former Soviet nations. The recent UK elections and upcoming elections in the European Parliament, and US, are likely targets for Russian propaganda. The US faces a presidential race between two elderly candidates, presenting a dismal choice for voters (although the Democrats are now looking to endorse Kamala Harris). Geopolitical tensions in the Middle East are escalating, further contributing to global uncertainty. The sharp rise in gold prices signals underlying concerns ignored by conventional asset markets, such as geopolitical risks and fiscal policies. With high global debt weighing on growth, a good investment strategy still includes diversification across global markets and asset classes. Although 2024 started strong, the remainder of the calendar year is expected to bring slower price increases and greater return divergence, necessitating caution.
At the beginning of the 2024 calendar year, the market expectation was a cyclical recession with a moderate economic contraction followed by growth. However, six months into the year, the market outlook has improved, leading to a more positive stance. By analysing leading economic indicators and insights from research analysts, it’s clear that economies are holding up well, prompting an increased willingness take on risk. Despite this optimism, there remains uncertainty about whether central banks have successfully controlled inflation, prompting a cautious approach to future scenarios and their investment implications.
Over the second half of the year, three main themes are being monitored:
- The likelihood of a soft-landing scenario versus a ‘mid-cycle’ environment
- China’s slow but improving stabilisation
- The overarching risks in the market.
Inflation is falling, but markets are resilient, suggesting a soft landing where growth stabilises around trend levels. However, the decision by central banks, particularly in Europe and the US, on rate cuts will significantly impact this trajectory. Europe’s potential rate cuts and the US’s persistent inflation and strong growth data, present challenges for central bankers, increasing the probability of a ‘no landing’ scenario where economies maintain current growth and inflation levels, potentially leading to further rate hikes.
Europe’s economic recovery is firmly on track, driven by strong domestic demand and better-than-expected GDP growth in the euro area, supported by resilient labour markets that have bolstered household incomes and sentiment. Disinflation trends may lead to interest rate reductions by the European Central Bank (ECB), though inflation remains elevated in some regions, necessitating cautious monetary easing. Fiscal policy must tackle tight labour markets and high public debt with more ambitious consolidation. Despite the recovery, Europe faces structural challenges like aging populations, climate change initiative costs, and low productivity.
In China, the focus is on controlled stabilisation amidst a property downturn, with growth shifting towards consumption and high-end manufacturing. Despite this shift, significant rate cuts from the People’s Bank of China are not expected until the US Federal Reserve signals a clear pivot. China’s annual growth rate forecast remains slightly below the official target due to insufficient policy commitment. Geopolitical concerns and the ‘China plus one’ trend are supporting diversification of supply chains, benefiting countries like Vietnam, Indonesia, and Mexico. Meanwhile, risks such as a potential rise in interest rates, the delayed threat of recession, geopolitical instability, and the disruptive impact of artificial intelligence on productivity and investment remain critical considerations for the market outlook.
Markets Summary
This year, over the half-year to 30 June 2024, market movements have included rises of 15% for the broad US market (S&P500), 18% for the technology-focused Nasdaq, 9% for Germany, the UK 6%, Japan 18%, and Australia 2%, while the French and Chinese markets declined slightly. The US market appears fully valued, but most others still appear attractively priced, especially small caps, if interest rates soon begin to decline.
Table 1 below shows how equity markets have moved around over the last five years. The table also includes the second quarter of 2024 and the 2024 year-to-date columns. The top number in each box is in Australian dollar terms and the bottom number if in the local currency, e.g. US = USD. (The reference portfolio is a JP Morgan Index portfolio and is not investible. The portfolio represents a balanced risk profile.)
USA
Wall Street’s performance underscores the market’s heavy reliance on the “Magnificent Seven”—NVIDIA, Microsoft, Apple, Amazon, Meta, Alphabet, and Tesla—which constitute approximately 30% of the S&P 500 and over 40% of the Nasdaq-100. These tech giants have reached new market-cap milestones, with Amazon exceeding $2 trillion and NVIDIA briefly becoming the world’s most valuable company. In mid-June, the Fed maintained its benchmark interest rate at 5.25%–5.50% and adjusted its rate cut predictions, now expecting only one cut in 2024 due to persistent inflation. Despite cooling inflation, economic indicators such as retail sales and manufacturing remain weak, impacting Treasury yields, which fluctuated between 4.70% in April and 4.20% in mid-June.
The market-cap-weighted S&P 500 gained 3.9% over the quarter, achieving record highs nine times, while the equal-weight index dropped 3.1% from its first-quarter peak. This disparity is largely driven by artificial intelligence, which has propelled significant gains for tech giants like Nvidia and Apple. Only three sectors—information technology, communication services, and utilities—outperformed or matched the broader index. NVIDIA and other semiconductor stocks surged, while software and internet services lagged, with companies like Salesforce and Shopify experiencing declines. Utilities performed unexpectedly well, with stocks like Vistra among the top performers. Despite these gains, 60% of S&P 500 components ended the quarter in the red, reflecting underlying market fragility as evidenced by the declining advance-decline line in June.
Europe
Eurozone shares declined in Q2, driven by uncertainty from the announcement of parliamentary elections in France and diminished expectations for significant interest rate cuts. The information technology sector performed well, particularly semiconductor stocks, while the consumer discretionary sector saw declines due to weakness in automotive and luxury goods stocks. The European Central Bank cut interest rates by 25 basis points in June, but further cuts may be limited by persistent inflation, which rose to 2.6% in May from 2.4% in April. Forward-looking data, such as the flash HCOB composite purchasing managers’ index, indicated a slowdown in the eurozone’s economic recovery, dipping to 50.8 in June from 52.2 in May.
Political developments were a key focus, with European parliamentary elections leading to gains for right-wing nationalist parties, particularly in France, where President Macron’s call for parliamentary elections caused French equities to underperform the broader eurozone index. Despite a notable 6.8% rise in European markets in Q1 2024, driven by easing inflation pressures and record highs in the Stoxx 600 index, the outlook remained cautious. Travel stocks led gains, while utilities saw declines. Economic data revealed mixed performance, with the UK having entered a technical recession in 2023, and Germany reporting slight employment increases. The technology sector in the eurozone, buoyed by AI-related optimism, led the charge, while utilities, consumer staples, and real estate lagged.
Japan
The Japanese equity market generated a positive return of 1.7% in yen terms for TOPIX Total Return over the quarter, but due to the yen’s depreciation, the return in foreign currency terms turned negative. The yen’s weakness was driven by a strong US dollar, supported by a robust US economy and expectations of prolonged high interest rates. The Bank of Japan (BOJ) took action in March, leading to a moderate rise in Japanese government bond (JGB) yields, which benefited financial stocks. Despite the BOJ’s plans to reduce JGB purchases in July, the yen continued to weaken, raising concerns about its impact on inflation and consumer sentiment. Real-term wage growth remained negative, and consumer sentiment stagnated, though spending was boosted by a record number of inbound tourists. The earnings season concluded with stronger-than-expected results, with companies showing sales growth, pricing power, and cost control. Market sentiment was dampened by conservative earnings guidance, but initiatives focusing on capital policies led to a record amount of share buybacks and positive stock price reactions. The TOPIX Total Return index achieved an 18.1% return, driven by foreign investors’ optimism about Japan’s economic cycle, with the Nikkei 225 remains elevated having surpassed 40,000 yen in March 2024, this continues to be supported by the BOJ’s significant policy actions and strong performance in the automotive and financial sectors.
Emerging Markets
MSCI Emerging market (EM) equities outperformed MSCI Developed market (DM) peers in Q2, driven by softer US macroeconomic data and a rebound in China. Turkey led the gains due to optimism about orthodox economic policies, while Taiwan saw double-digit returns fuelled by investor enthusiasm for technology stocks, particularly those related to artificial intelligence. South Africa’s performance was boosted by the formation of a coalition “Government of National Unity” following the general elections, and India’s equity market was supported by political developments, with Prime Minister Modi’s party retaining its parliamentary majority. Emerging European markets like Hungary, the Czech Republic, and Poland also performed well. China’s recovery in April and May, supported by positive government actions for the housing sector and reform rhetoric, further aided EM returns. However, Korea and energy-related markets like Kuwait, the UAE, Colombia, and Saudi Arabia underperformed. Brazil and Mexico saw the biggest losses due to central bank caution on interest rate cuts and political concerns, respectively. Despite these mixed performances, EM economies according to the International Monetary Fund (IMF), are projected to grow robustly, with a growth differential widening compared to developed markets, driven mainly by Asian countries amidst a favourable disinflation trend.
Australia
Australian investors have navigated a prolonged period of declining and ultra-low interest rates, with no rate hikes between November 2010 and May 2022. The recent rise in interest rates underscores the opportunity cost of capital and the importance of conservative capital structures. During the era of low rates, debt was seen as ‘free,’ encouraging borrowing for acquisitions and growth with little regard for financial risk. Now, with the end of ‘free money,’ the significance of robust balance sheets has returned. Corporate balance sheets in the ASX 200 are in good shape, suggesting that Australia’s largest companies are well-prepared to handle economic challenges. The grocery, airline, and banking sectors, dominated by a few key players, provide stability for large-cap investors due to their lower risk of competitive disruption.
The S&P/ASX 200 Total Return Index rose by 1.0% in June, ending the month above its previous trading range. Forward earnings declined by 0.5% in June and are down 3.0% over the past year, contributing to the Australian market’s underperformance relative to global peers. Despite these challenges, sectors and factors like technology, financials, and quality performed strongly in June, supported by the prospect of lower local interest rates and a stronger housing market, although concerns about China continue to impact resource stocks.
You can download the entire Quarterly Investment Update HERE
Regards,
Marshall Brentnall, the AAN Asset Management Investment Committee
