Sovereign Wealth Partners and InvestSense Pty Ltd
Markets made strong gains in the first two weeks of the month with a reflation and risk-on being the dominant themes with tech, energy and financials all enjoying the biggest gains.
During that period interest rates were grinding their way up but the market seemed unconcerned about the prospects of higher borrowing costs. It turns out that as 10-year rates closed in on 1.5% in the US (and interestingly a bit higher than that in Australia) the frog boiled, and markets fell sharply. Many in the market had assumed that this kind of reaction would kick in at around 2% but it is perhaps the speed with which the rise in rates has gathered pace that has spooked markets. Our economy is a bit of a bellwether and it is also significant that having tracked US rates for some months our long-term borrowing costs have risen recently at an even greater clip.
At the very beginning of the month the RBA announced $100bn of quantitative easing in order to ensure that our rates didn’t rise quicker than those of the US and that the currency didn’t start appreciating too quickly, thereby making our exports less competitive in a fragile global recovery – it seemed to do the trick for about half an hour. While the world frets (quite a lot as it happens) about a 0.4% rise in 10-year US rates, ours have risen by almost 0.8% and most of that happened in the last week of the month. This is quite big news for the world and especially for Australia (and its heavily indebted homeowners).
For equities that meant that energy and bank stocks held onto their gains (15% and 10% respectively) while tech stocks and other interest rate sensitive sectors like utilities real estate were down sharply, as were some of the more defensive sectors like consumer staples and healthcare. Metals and soft commodities also ended the month well into positive territory underscoring the fact that, for now, the economic recovery is not seen to be threatened by higher rates.
In other (now less exciting) news the Australian reporting season drew to a close with companies generally beating expectations, led by the Materials, Healthcare and Information Technology sectors. However, these were also the very sectors that led the market down – valuation and discount rates matter just as much it appears. While IT stocks were down almost 10% for the month (and some 20% from their mid-month peak) they are a small part of the market index and the fact that banks were up 5% meant that the equity market remained up over 1% for the month. Interestingly global banks are a smaller but still significant part of the world market but (being up 10%) they also accounted for the lion’s share of the global stock markets gains of 1.5%. So last week’s gains for equities here and abroad was pretty much down to banks, the main beneficiaries of steepening yield curve (they pay short term interest to depositors and receive long-term rates from borrowers.
Finally, and as one might imagine, currency markets, also got a bit more interesting with most currencies appreciating by about 5% in the first three weeks of the month against a weak US Dollar. This pattern was a strikingly uniform – it is quite unusual for the Aussie Dollar and Japanese Yen, for instance, to move in sync to that degree. Then almost all of that was reversed in the last week of the month as the US Dollar strengthened against everything else. Quite a few fund managers and economists have told us that US Dollar strength would be both a harbinger and a cause of risk in the global financial system.