Sovereign Wealth Partners and InvestSense Pty Ltd
Volatility crept back into markets towards the end of the month, especially in the US, as China’s COVID woes weighed on markets early in the week before the S&P 500 rose by 3% in a few hours after US Fed chair Jerome Powell intimated that the rate of interest rate hikes might at least slowdown from here. Along with the hope that headline inflation numbers are peaking in the US (and maybe even in Australia) is the suspicion that central banks are just as focused on higher frequency data and why inflation is coming down. On the one hand recent rental data suggests an easing of pressure for instance but there also remains upwards pressure on spending and wages.
In terms of the big movers, it was iron ore prices and our local miners up 20% for the month accounting for most of the 6.5% gain made by the local stock market. This was only matched by the local Utilities sector (well actually Origin Energy which was up by 40% after a takeover bid by Brookfield Asset Management).
At the other side of the ledger oil prices were down by 10-15% which is unusual as energy prices and industrial metals more commonly move in sync, driven by the economic outlook. In this strange cycle the oil price has become highly politicised and driven by supply rather than demand while the iron price is hopefully picking up on a potentially softer landing and/or a reopening inspired Chinese recovery. The headlines in the last week or so of the month seemed to mitigate against this (it is looking like it might be very difficult for China to reopen in the aftermath of their Zero COVID policy with such low levels of vaccination amongst the elderly).
However, the Chinese market has also been on a bit of tear in recent weeks with many property stocks doubling in value and the market as a whole up by 15% and 20% depending on how you measure it. This note of optimism was echoed in European markets which were up by 10%, followed by emerging markets (8%), UK (6%), the US (5%) and Japan which was, again marching to its own tune, flat for the month. Given that most value managers are also overweight Europe (and US Industrials which were also up but 10%) it was a good month for value while growth managers struggled despite rebounds in many of the large growth stocks like Microsoft, Alphabet, Facebook and Nvidia.
Within bond markets the soft-landing theme was also seen in falling corporate credit spreads (which compensate investors for the likelihood of default) while government rates were also down across most Western markets during the month. During that period market implied measures of expected medium-term inflation actually ticked up (especially in Australia) which in turn meant that medium term real interest rates dipped quite significantly and in Australia are back into negative territory. These metrics effectively describe the price of money in the future while measures of liquidity (how much debt is being issued by governments or banks) measure the quantity of money. These metrics were also quite supportive of markets and offer another reason why markets were so buoyant in November. In terms of the price and quantity of money financial conditions actually eased in November. This might explain the apparent contradictions of buoyant markets as the world braces for an imminent recession.
Either way it was a tide that lifted all boats and, if during most of the year it felt like there was nowhere to hide, in November it was difficult to lose money as most other assets ended the month up. Real Estate and Infrastructure were both up around 6% in unison having traded very differently throughout the rest of the year. Corporate and government bonds also traded differently with the ebbs and flows of economic growth and inflation expectations respectively but were both up by a few percent, meaning that fixed rate corporate credit was also up by 5-6%. Underpinning some of this was weakness in the US Dollar against most currencies including the Australian Dollar, another manifestation of easier financial conditions and a barometer to keep an eye on if this version of Goldilocks is to last.
Our base case for now is still somewhat cautious given a noisy data environment and the possibility of higher rates and lower growth as outlined above. As we approach levels that we perceive to be closer to fair value it is natural that our conviction levels on overall market direction wane but there is always something in relative valuations to keep us interested.
If the big discrepancy at the start of the year was between US equities and the rest of the world this year’s sell-off in listed markets has opened up another one – between listed and private markets. A good article in the Economist this week shines a spotlight on the fact that the valuations of illiquid assets like private equity and direct property have not moved nearly as much as listed equivalents so far this year. Listed markets could fall further and private markets may not need to adjust in a hurry, but we think it is getting more difficult to argue, on a ten-year view, that investors are likely to get a much better deal as result of locking up their money for long periods and the opposite may well be true.
This is especially true of mature assets such as infrastructure and property that were bought at high multiples in recent years justified by ultra-low rates that are unlikely to reappear. Arguably fresh capital applied to earlier stage ventures may be starting to get a better deal. The article is probably not pay walled for the occasional economist reader but let us know if you would like a summary.