Sovereign Wealth Partners and InvestSense Pty Ltd

Market Commentary

Most major equity markets declined throughout April as incrementally hawkish rhetoric from central bankers and the subsequent adjustment in interest rate expectations sent jitters through global markets.

Much of this pain was felt in US markets primarily due to their comparatively expensive tech stocks having increasingly become a lightning rod for concerns around interest rates.

The tech-heavy Nasdaq finished the month down -13.2%, marking its worst monthly performance since October 2008, while the broader S&P 500 Index (arguably the most popular measure of the US stock market), finished the month -8.7% lower.

However, it was notable that despite a fairly positive earnings season so far, the market is now also worrying about the economic sensitivity of these stocks in the post-COVID environment, one that might include a recession in the not-too-distant future.

While the negative US GDP number towards the end of the month was also unexpected, the market didn’t actually take this too badly as it was seen to be a technical issue due to rising imports, and actually a sign of a stronger than expected US consumer.

Overall, it has been a particularly noisy environment and a raft of economic data releases and central bank decisions over the coming weeks are unlikely to change this. Chinese stocks, and by extension emerging markets, have also been under pressure in the last month as the intractable nature of widespread lock downs in China, where effective vaccination rates are very low, has become increasingly obvious. However, many prominent Chinese tech stocks like Alibaba jumped 20% or so when the government announced measures to stimulate the economy.

The UK and Australian markets continued to navigate all this fairly serenely while Japan and most other Asian markets also proved less volatile. Even European shares proved surprisingly robust last week given the rising concerns around energy security in the region.

Domestically, this was in the context of a surprisingly high local inflation print last week and a consensus that the RBA would be forced to act sooner rather than later, so clearly local shares are not being seen by the market as vulnerable to interest rates in the way that US stocks are.

Of course, all this talk of inflation and rising rates continued to put pressure on bonds and in recent weeks rising credit spreads have added to the falls experienced by bond investors, a trend which accelerated slightly last week. Government bonds here and abroad are still down the most this year (by about 6-7%) but local floating rate credit investments have also been on the ebb and are now down 2-3% for the year after a 1-2% fall in April.

Australian investors did get a boost from rising currency volatility in April as a weaker Australian Dollar cushioned much of the falls experienced by US equity holdings (a falling Australian Dollar means that holdings denominated in US Dollars, like US equities, are worth more in AUD).  Meanwhile at the other end of the spectrum the Japanese Yen has depreciated in a manner not seen for decades. The Yen usually appreciates in times of stress but the Bank of Japan’s insistence on maintaining ultra-low rates as other central banks move to head off inflation has undermined the value of the currency. This is just one prominent example of currency volatility that has been on the rise recently around the world and is generally not seen as something that gauges well and so perhaps worth keeping an eye on.

Looking Forward

We have been surprised by just how quickly everyone from retail investors to seasoned fund managers have adapted to thinking in ‘real’ terms, that is to say by taking into account the corrosive effects of inflation on real wealth outcomes when making decisions (rather than suffering from nominal ‘money illusion’ as has typically happened at the onset of previous inflationary episodes like the 1970’s).

This is most obvious in the clamour in the US around wages which are climbing at a good clip in nominal terms but actually going backwards after currently high levels of inflation are accounted for. This is also starting to be widely discussed in Australia. Underlying this is the sense that high single digit inflation could be with us for a while. Having been in the inflation camp for a while we had started to wonder whether this thought had almost become too well entrenched in market and consumer psychology.

Meanwhile an important US earnings season continues unabated. So far this reporting season has reminded us that markets are relentlessly forward looking. At certain points in the cycle 7% earnings growth might be seen as an OK outcome. However, this time around there is the thought that, again, in ‘real’ terms this might not be such a great result and it is also a sign that momentum in earnings (which tend to be quite cyclical) is on the wane (it is the lowest number we have seen since the start of the COVID recovery in late 2020). Lastly, forward guidance has been even more underwhelming which is what we and most in the markets will be focusing on as the focus moves from the tech giants that dominated the headlines last week to a broader range of consumer and industrial stocks, as well as from some large international companies in Europe and Japan.