Quarterly Outlook June Quarter 2023
Graeme BibbyChief Investment Officer
Are we there yet? Recession postponed but still to come.
- Inflation falling but core inflation still relatively high
- Central banks surprising with more cash rate hikes amid pauses
- Equity market returns and credit spreads low has been generally positive with lower volatility
- Strength in employment despite falling cash reserves pushes the economic downturn at least out to end of year
- Hence, equity and credit market weakness is likely much later this year and short term can rally this quarter
The June 2023 quarter was healthy for equities marking a recovery from the weak performance in the first quarter. This was aided by a resilient economy and labour market. Services were particularly strong and spending appeared sourced from cash reserves that were visibly drawn down for households and corporates. Offshore equities performed better than Australian equities while bonds rose in yields and fell in value for the quarter. Inflation appeared to have peaked but remained a focus for central banks, with surprise further hikes by the Fed and RBA. While consumer and business confidence remained challenged in the US and Australia, positioning into equities improved for retail investors while most wholesale investors remained underweight. We believe that there is likely some capitulation of institutional investor positioning as equities runs up further, with evidence seen in broker year end estimates for equities being raised. While we believe in the short term that some rally can continue, we are still managing to the downturn that appears much more likely towards the end of the year as cash holdings dwindle, price pressures feed through and companies finally cut costs through job cuts.
Our analysis of prior cycles and a range of independent research has lead us to continue conviction in our view to be underweight risk assets, albeit we are likely to make some adjustments at the edges. For example in environments of high inflation such as the period of the late 1960s there was a delay in the impact on corporates and households due to the ‘money illusion’ of higher nominal growth. We may appear nominally better off from higher wages, but in real terms our purchasing power is declining. The corporate ‘hoarding of labour’ can last for only so long, which has been a response to the immediate post covid period of scarce labour. However now we have record migration, and cyclical sectors are under pressure. It is a very different economic and market cycle at present to any time in the last 50 or more years, hence caution with our analysis to look to a wider and longer perspective for insights.
Quarterly Market Performance
- Equity markets were up over the quarter in most markets
- Government bonds rose in yield and bond indices fell on central bank actual and prospective hikes
- Credit spreads on corporate and financial bonds fell as bank contagion fears subsided
- Currencies were led by strength in the USD, while the AUD, JPY and EUR weakened
- Commodities were weak in energy and metals
- Volatility measures fell in equities, bonds, currency and gold
Australia’s GDP rose by 0.2% for the quarter and 2.3% for the year to March, declining from the prior quarter. Inflation was 1.4% for the quarter and 5.6% for the year to December, declining from the prior quarter. Unemployment rose to 3.6% in February, unchanged on a quarter before. Forward looking indicators are declining, particularly in the national Purchasing Manager Indices (PMI) that indicate a trend downwards in manufacturing and services indices and are currently slightly contractionary.
The United States’ GDP rose by 0.5% (2.0% annualized) for the quarter and 1.8% for the year to March, declining quarterly but rising annually from the prior quarter. Headline Inflation declined to 4.0% to May, declining each month since the beginning of the year. Unemployment moved up marginally to 3.57% in June from the 3.50% low the prior month, flat for the quarter but down year to date. Forward looking indicators from the PMI indices for manufacturing continue a bumpy downward trend for two years while services have remained resilient this year aside from last month's weakening. Small business optimism continued a downward trend this year, continuing from last year while consumer confidence has rebounded this quarter.
The Eurozone GDP was flat at -0.1% for the quarter and 1.0% for the year to March, declining from the prior quarter. Inflation was at 6.1% in June, continuing the downward trend since peaking at 10.6% in October 2022. Unemployment was at 6.5% in May, the lowest level this year. Forward looking indicators from the EU PMI indices have been trending lower with manufacturing contractionary and services declining but still expansionary for now in the quarter to June 2023. Consumer confidence is improving but still pessimistic while business confidence across manufacturing and services sectors were trending down this quarter.
China’s GDP rose 2.2% for the quarter and 4.5% for the year to March, up from the previous quarter. Inflation continued a downward pace over the quarter of 0.2%p.a. in May, partly driven by negative producer price inputs, rising from a negative pace a quarter earlier. Unemployment was at 5.2% in May, declining over the previous quarter. Forward looking indicators from PMI indices for manufacturing were weakening and contractionary while services were also weakening from stronger levels. Consumer confidence is strengthening.
The consumer and business sectors have been resilient, particularly with employment not faltering as might have been expected given the slowing in forward looking indicators. That this is a very different cycle is realigning some of the expected timelines given we have inflation to deal with. Employers holding on to labour in the face of slowing and consumers spending despite drawing down on savings are two examples of a different kind of business cycle. While we do see tightening conditions from higher interest rates and lower loan growth, the perception that growth is still fine keeps the economic music playing. However, we do expect that slowing momentum in economies and money supply will eventually gain traction later this year as limits do eventually prevent consumers and businesses from continuing spending and hiring. We expect the ultimate slow down and recession to be postponed rather than avoided, while in the interim we may well see further risk taking activity in markets for a quarter or two. We watch the labour statistics very closely and for leading sectors such as housing which we expect may reflect limits of higher interest rates for those rolling off lower fixed rate mortgages. Central banks that are likely to keep hiking rates even while inflation is falling are another factor likely to increase the probability rather than the timing of an ultimate recession. Whether it is the US, Australia, or Europe, the central bank behavior is for tightening, while Chinese policy makers are very cautious in their incremental stimulus measures that aren’t going to keep the rest of the world out of a downturn. A recession in Australia and the US either end of this year or early 2024 is our base case view, though resilience in the labour market could see this further delayed.
Asset Class Performance and Outlook
We believe there are continued the negative underpinnings for Australian Equities from very lagged effects from tighter monetary policy on businesses and consumers, and growing pressures on bank credit provision. We also see business insolvencies picking up to the highest levels seen in about 10 years as pandemic stimulus support wanes and rising interest, materials and labour costs impact businesses. However there have been quite resilient economic data in retail sales and unemployment, noting unemployment is the most lagging indicator. Australian institutional investors have remained on the whole cautious however we are alert to any capitulation and buying on more positive offshore equity momentum. We remain cautious in our positioning, continuing to overweight defensives and quality.
International equities have performed better than Australian equities this quarter, following a divergent trend since the beginning of the year. We are seeing a focus on large cap technology stocks, particularly those connected to the artificial intelligence wave. Hence we are seeing the top 7 S&P stocks and the NASDAQ performing quite well this year.
Bond markets were subdued for most of the quarter but rose in yield towards the end as the reality of a persistent Federal Reserve indicated more rate rises were likely. Some higher volatility ensued around conflicting US employment data from different measures. However, we see bias still on the upside for yields while credit spreads remain more subdued. We would expect credit spreads to widen later this year as the delayed economic slowdown gets traction.
This information is general in nature and is provided by Partners Wealth Group. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information.