Global and domestic equities continued to fall in the month of October before rebounding in November, historically the strongest month for stocks since 1950. The S&P/ASX200 declined 3.78% last month and is now at a flat year-to-date return of -0.21%. In October, the MSCI World Index followed with a 2.6% fall (up 9.61% year to date) while the S&P 500 and NASDAQ fell 2.1% and 2.76%, respectively (Chart 1). This comes amid investor fears of a “higher for longer” interest rate environment and conflict in the Middle East that threatens to send oil prices surging. The price of crude oil has now moderated to $85.1 per barrel, down from its $96 high in September. However, ongoing conflict in the Middle east, Russia’s invasion of Ukraine, and the continuing production cuts is likely to see price increases through 2024. This adds to the uncertainty of the inflation outlook for next year.
Equity market volatility continues to coincide with bond markets, as treasury yields remain a focal point for investors. Long-term US Treasury yields crossed above 5% in October and ended the month at 4.90%, up 33 basis points from the previous month, while the Australian 10-year bond yield was up a further 44 basis points, surpassing the US to reach 4.92% (Chart 2). As equity market retraced higher in November, bond yields are in retreat, driven by decisions made by the Federal Reserve and U.S. Treasury. Last Monday, the Fed announced that because higher tax receipts are expected, it will issue less debt in the fourth quarter, which pushed yields down. Additionally, the bank’s policy-setting committee kept rates unchanged for a second consecutive meeting, and Chairman Jerome Powell offered commentary that suggested the bank may be close to finishing the series of rate increases. He acknowledged that inflation has come down and financial conditions have tightened, also seen through signs of slowing US jobs growth and an uptick in unemployment.
RBA Decision Incoming
While inflation shows signs of abating in the US, Australia’s September quarter CPI came to 1.2%, exceeding the 0.8% June quarter print (Chart 3). This was slightly above economists’ expectations for a 1.1% rise on the back of oil price spikes and soaring petrol prices that increased cost of living pressures. The Reserve Bank of Australia (RBA) has left its cash rate unchanged at 4.1% for the past four months, however, a Reuters poll showed almost 34 of 39 economists anticipate a 25 basis point rise in rates to 4.35% at tomorrow’s meeting. In her first speech since becoming RBA governor, Michele Bullock said “The RBA board will not hesitate to raise the cash rate further if there is a material upward revision to the outlook for inflation”. This material upward shift has now occurred and therefore raises the likelihood of a rate rise before the end of 2023, which is reflected in trader positioning ahead of tomorrow’s RBA decision.
Meanwhile, the Australian Dollar ended October at its previous month’s low of US63¢ on the back of the RBA’s comparatively lower cash rate relative to other central banks. Early this month however, the US Dollar depreciated broadly following the Fed’s decision to keep interest rates unchanged, strengthening the AUD to US65¢. Should the RBA decide to increase the cash rate tomorrow, this will give the Aussie Dollar an initial clean run however the global picture will still impact the exchange rate over the medium and long term. China’s PMI (Purchasing Managers Index) contracted once again in October to 49.5, missing analyst estimates of 50.2 from a Reuters poll. The Chinese economy is grappling with weak consumer spending, a deepening property crisis and subdued global demand that presents medium to long-term concerns as Australia’s largest trading partner.
As markets price in the “higher for longer” narrative, while still hopeful of a soft landing, it is important to maintain a robust investment framework, remaining invested through the cycle, as short-term volatility is to be expected. Investors do not always behave rationally, which can cause markets to often overreact to news, both good and bad. This is why it is crucial to emphasise long-term portfolio goals over short-term market movements.
Following a quarterly portfolio review, LBP has opted for a more defensive positioning with a moderate underweighting to equities and other growth assets, and an increased allocation to private debt, fixed income, and cash for dry powder should attractive opportunities arise. This is in line with BCA’s third quarter 2023 Strategy Outlook that concluded it expects to downgrade equities to underweight before the end of the year in favour of low risk fixed income assets as the equity risk premia falls.
Fixed income markets have undergone structural changes over the past year, with yields reset at much higher levels. This creates an opportunity to invest in high income assets that have a lower risk relative to equities. Private debt markets are also experiencing structural tailwinds through positive supply-demand dynamics, driven by regulatory changes resulting in major banks significantly reducing exposure to middle market financing.
We continue to maintain an allocation to real assets and alternative investments to diversify portfolios. Given the weak Australian Dollar, it may be appropriate to increase hedging in your portfolio to protect against a rising AUD in your international holdings. LBP reiterates that the main focus should be on long-term objectives and capital preservation as time has shown that the greatest threat to wealth tends to come from being underinvested in the long term rather than remaining invested through short-term volatility.
We encourage you to contact us should you wish to discuss this further or if you have any questions about how these trends are impacting your portfolio.