Life - and investment markets - love a paradox.
After the initial shock, the Great Lockdown saw markets soar. Today, despite unemployment in major economies near record lows, consumer pockets stuffed with cash and business activity running hot, real estate, equities and fixed interest assets have all cratered.
The June 2022 Perpetual Private Quarterly Market Update looks at how markets and economies shifted over the past quarter and why the price of money explains the paradox above. You can download the full report – or read our concise review below.
June Quarter 2022: What happened?
- After avoiding the worst of the inflation/rising rate selloff in the previous quarter, Australian Equities played catch-up with the rest of the world – dropping over 12%. Only the tech-heavy NASDAQ performed worse amongst major developed market indices. That number hid significant differentiation – the local Utilities and Energy sectors generated positive returns for investors. But our tech stocks fell more than 26%
- Global shares lost nearly 8% over the quarter and are now down 15% for the first 6 months of 2022.
- Around the globe and here at home, rising rates brought listed property back to earth – down 17% in Australia and 9% for global indices.
- Global bond markets, traditionally a safe haven, were instead storm-tossed – down over 9% over the past two quarters.
(Indices referenced: S&P/ASX 300 index , S&P/ASX 300 Utilities (Sector) - Total Return, S&P/ASX 300 Energy (Sector) - Total Return S&P/ASX 300 Information Technology (Sector) - Total Return, MSCI AC World Index - Net Return. S&P/ASX 300 A-REIT (Sector) - Total Return index, MSCI World / Specialized REITs -SUB - Net Return index, Bloomberg Global Aggregate (AUD Hedge). All performance numbers for June quarter unless otherwise stated).
Post-traumatic inflation disorder
In opening every available cash spigot to offset the economic trauma of the Great Lockdown, central banks and governments around the world set inflation running. There was debate about how transitory that inflation would be but it’s now clearly in danger of becoming embedded. So central banks are turning off the taps. In many cases the imperative to do so is baked into their charters and most are signed up to the view of the Bank of International Settlements (BIS): “As historical experience has shown time and again, the long-term costs of allowing inflation to become entrenched far outweigh the short-term ones of bringing it under control.
By raising rates – sometimes dramatically – central banks are trying to reduce the excess demand that’s driving inflation in the global economy. Their balancing act – between crushing inflation and crushing growth - is complicated by China’s zero-Covid policies and the war in Ukraine, which the BIS called, “Probably the most significant geopolitical event since the fall of the Iron Curtain.”
The sector most affected by this re-calibration of interest rates is technology. In the first six months of 2022, the NASDAQ index has fallen by 25.2%. Even the (mostly) highly profitable FAANGM stocks - Facebook, Amazon, Apple, Netflix, Google and Microsoft - are under pressure. Andrew Garrett, Investment Director at Perpetual Private says, “These companies have gone from strength to strength for more than a decade. Now they find themselves with shrinking valuation multiples. And investors are no longer prepared to give them the benefit of every doubt.”
Changing of the guard
As Andrew points out in the video above, the market virus in tech stocks has helped build a general wall of worry affecting most asset classes. But Andrew also points out that a world where interest rates are no longer set to ‘emergency’ is not something to fear – it’s a return to normal. In this he’s joined by the Governor of the Reserve Bank, Philip Lowe, who announced his recent 0.50% rate rise by talking about “normalising monetary conditions.”
So what are the investment implication of this changing of the guard? For a start, the intravenous sugar-hit given to growth shares by years of ultra-low interest rates is probably over. In the past quarter, Value companies significantly outperformed, falling only 3.4% in a period where Growth shares fell nearly 14% (measured by MSCI AC World Index Growth - Net Return and MSCI World Index Value - Net Return). With interest rates rising and offering an alternative to dividend income, companies paying out cash now are more attractive than those priced on earnings coming down the track years in the future.
Similarly, a higher rate world is one that’s more nuanced, where money won’t flow in and out of markets in “risk-on” or “risk-off” waves. According to Andrew Garret that pattern will be replaced by investors asking, “which risk and when.” In short, we’re moving into an environment that’s good for active investment managers and those that look for value.
Now isn’t always
The other good news for investors is what you might call the self-correcting mechanism. Much of the inflation we’re facing is driven by supply chain issues which are slowly starting to ease. That easing will be helped if, as expected, China finds a way to fight Covid that doesn’t mean shuttering whole cities. That trend – and any stabilisation in Ukraine - could ease inflation pressures and let Central Banks take their foot off the brakes in 2023. That doesn’t mean a return to ultra-low rates – which probably aren’t desirable anyway – but it does mean investors won’t be leaning against the Fed (and other central banks). And that provides conditions, ideal for investment managers to drive out performance.
Perpetual Private’s Quarterly Investment Update for March to June 2022 covers these issues in greater depth, with detailed analysis of individual asset classes including equities, fixed income, real estate, currency and alternatives.
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