Investment Market Performance
It was another good period for investors in the January to March 2024 quarter, continuing a good run for share market investors as the share price accumulation indices shows. This measures the movement of share price plus dividends being reinvested and compounded. However, this was followed by a short and shallow fall in April and markets recovered to their all-time highs by mid-May.
The overall positive performance this year has been driven largely by the ongoing resilience of the US economy, falling inflation in the US, and advanced economies, (increasing slightly in the last few months), and the peaking of the interest rate tightening cycle combined with hopes of interest rate cuts, which are now uncertain in their timing.
Tech and artificial intelligence
The Artificial Intelligence theme led by Nvidia had a significant impact on the US market, which itself represents 70% of the global equity index. The 1-year return of Nvidia to 7 May 2024 was 216% compared to the US S&P500 return of 26%. The top 20 listed technology companies combined make up over 30% of the US S&P500 index.
Returns of major asset classes to 30 April 2024
The returns reflect the market dip in April, which has since been reversed following a marginally softer US inflation result. This broke a three-month run of higher-than-expected inflation data. Nevertheless, the table shows the ongoing strong share market returns, especially over a 6- and 12-month period. The fall in the Australian dollar (AUD) boosted global share market returns in AUD terms.
With signs that the Australian economy is weakening, this year continues the relative underperformance of Australian large cap stocks. However, small cap stocks and Australian Listed Property have performed well over the last 6 months.
10-year bonds in Australia and the US continue to have good yields, and the cash rate remained unchanged in the last quarter.
Outlook for economies and markets
The outlook for the next few months is mostly positive, with most market commentators expecting a
“soft landing”. This is when an economy comes out of a strong growth cycle with a slowdown without entering a recession. However, several important issues may result in equity returns being lower and more volatile than the unusually strong returns over the last year.
Liquidity will be the biggest driver of the share market in the short term, and the key issue is when and by how much Central Banks will begin to cut rates.
The markets are focused on the US economy as developed markets outside the US, including Australia, are significantly weaker. A major issue is that inflation is well above the US Federal Reserve US Fed) 2% target. Added to this is the strength of the US jobs market and a significant rise in manufacturing input costs. The US Fed has made it clear that persistently high inflation is likely to delay any US rate cuts. The market now does not expect any interest rate cuts until late 2024 at the earliest. A related issue is the high levels of ongoing inflationary budget deficits and the record high level of US government debt, which represents 126% of US Gross Domestic Product (GDP).
The prospect of US inflation continuing to increase when the economy is slowing has led to an increasing number of market commentators fearing a return to stagflation (where inflation is high, economic growth slows, and employment remains high) or a US recession. Consequently, we expect inflation and bond yields to be higher than in the recent past.
The Australian economy is slowing down, with economic growth forecasts recently revised down to 1.3% p.a. for the June 2024 quarter. Recent data has shown inflation above forecasts, with the Reserve Bank of Australia indicating that rates will remain higher for longer.
The relatively high valuation of shares in both the US and Australia also limits the upside in share market returns. Valuations have risen to a level where the dividend yield on shares is less attractive than bonds.
The returns on government bonds (and investment grade credit and cash) are potentially quite good, with longer dated fixed term bonds also having the ability to deliver significant capital gains when interest rates eventually fall.
Conclusion
Given the factors discussed above, we are cautious about the outlook for markets for the rest of the year.
Conditions support diversification because, while we think growth assets overall may remain positive, they will likely be volatile, and defensive components of portfolios provide both good yields and an opportunity for capital growth in the case of bonds.
Investors should also remember that significant geopolitical tensions in many parts of the globe can negatively affect portfolios.
