Future investment strategy

For the March quarter of 2023

Economic

Global growth prospects for 2023 have improved significantly since December, says Fitch Ratings in its latest Global Economic Outlook report, but the impacts of rate hikes on the real economy still lie ahead and are likely to push the U.S. economy into recession later this year. The ratings agency now forecasts world growth in 2023 at 2.0%, revised up from 1.4% in December 2022. While China’s 2023 growth forecast has been increased to 5.2% from 4.1% in December, eurozone growth upgraded to 0.8% from 0.2% and U.S. growth to 1.0% from 0.2%. While growth forecasts for 2024 has decreased from 2.7% to 2.4% to reflect the lagged impact of rapid U.S. Fed and ECB interest rate hikes.

Markets

Share market performance in both the U.S. and Australia was positive for the March Quarter. The S&P 500 rose by 7.03% for the quarter, while the Australian S&P 200 rose by 3.46%.

In Australia, Quality and Equal Weight were the best performing styles for the quarter. Small caps, according to the MSCI World Index, was the only style to produce a negative return (-0.1%). Globally, Growth and Quality were the best performing styles, with Momentum being the only style in negative territory.

Within Fixed income markets, both government bonds and credit gained ground this quarter. The main Australian fixed interest index, the Bloomberg AusBond Composite 0+ Years Index gained 4.6%, while the Bloomberg AusBond Credit 0+ Years Index gained 3.4%. Global High Yield bonds, as measured by the Bloomberg Barclays Global High Yield Total Return Index Hedged into AUD gained 2.3% for the quarter. Given the whole Australian Government yield curve is now lower than it was one month ago, composite Australian Fixed Interest funds are now looking somewhat less attractive, when compared to a month ago, but are still significantly more attractively priced than they were at the start of 2022.

Global equity markets

March was an interesting month for risk assets, especially longer duration growth companies.

Growth companies such as those within the Nasdaq Composite Index bottomed around October last year and rallied strongly into 2023. The market was factoring that Peak US Inflation had passed and we were near to the top of the interest rate cycle. U.S. Government bond yields plunged in March due to the collapse of 3 U.S. regional banks and the fear of systemic contagion. This provided strong support for growth company prices, as the discount rate for their valuations decreased.

The overlap between the performance of Global Growth and Global Quality continued as both rebounded strongly in March and both styles lead over the past 6 months.

Research notes the top ten holdings of the MSCI World Quality Index and the MSCI World Growth Index have 7 companies in common (Microsoft, Apple, Alphabet A & C Class, Nvidia, Meta Platforms, and Visa).

Australian equity markets

The Australian market, as measured by the S&P/ASX 200 Index excluding dividends was down -1.1% over the month of March. The MSCI Australia Index lagged its global counterpart MSCI World Index in local currencies by 2.5% due to lower exposure to technology and higher growth companies, especially compared to the U.S. This can also be seen in the 1-year performance figure, as the MSCI Australia Index wasn’t dragged down by the high valuations in technology and growth companies.

The small companies’ section of the market lagged in both the World and Australian data. While the lower global bond yields provided some support, smaller companies are usually more economically sensitive and a reduction in bond yields due to fears of a credit crunch is not favourable for the economy or small company earnings expectations.

Australian bond market

During the quarter, as far as bonds go, we saw good months in January and March, and a poor performing month in February. Overall, the March quarter was generally positive for bonds. The main Australian Fixed Interest index, the Bloomberg AusBond Composite 0+ Years Index rose by 4.6% for the quarter, which was a great result. Australian yields tightened over the quarter, with the short end (3-year) of the curve falling by 59 basis points. At the long end of the curve, the 10-year yield fell by 75 basis points.

Australian corporate bonds also gained ground over the quarter, with the Bloomberg AusBond Credit 0+ Years Index returning 3.4%.

The yield to maturity at the quarter’s end was 4.05% for Australian Bonds, with the index having around 5.2 years duration. This makes most mainstream Australian Fixed Interest funds significantly more attractive than they were at the start of 2022 when the yield to maturity of the Index was around 1.7% with approximately 5.7 years duration.

US bond market

Over the March quarter, U.S. Government bond yields rose on the short end of the curve but fell on the long end of the curve.

The U.S. yield curve rose most noticeably for the below 1-year range but fell noticeably for maturities of greater than 3 years. Note the 2-year / 10-year part of the curve remains significantly inverted at -109 basis points as at the end of the quarter. This is clearly indicating that a recession is expected.

In the U.S., credit spreads were mixed for the quarter, with Investment Grade credit spreads rising by 10 basis points, while High Yield spreads tightened by around 20 basis points. Overall, global High Yield bonds as measured by the Bloomberg Barclays Global High Yield Total Return Index Hedged into AUD gained 2.3% for the quarter. Note the U.S. makes up the large majority of the high yield market globally.

While the small widening in investment grade credit spreads detracted from performance for the quarter, the duration element of this market more than offset the small loss from the spread widening.

While nominal yields on corporate bonds continue to look reasonable on face value, most major U.S. economic indicators, with the exception of unemployment, continue to show the U.S. is in an economic downturn. So, at this point in the cycle, we continue to see duration exposures as somewhat preferable to credit.

Currencies

The ICE US Dollar Index (DXY) – a measure of the currency’s strength against a basket of mainly trading partner currencies including the Euro (EUR), Japanese Yen (JPY) and British Pound (GBP) – stood at the 102.5 as of 31 March, declining from its early March short-term highs.

The U.S. bond market yields reacted very quickly and strongly to the collapse of Silicon Valley Bank, Silvergate Bank and Signature Bank, with sharp declines across the yield curve. The U.S. 2-Year Government Bond yield declined 1.02% in 3 days. This sharp move in U.S. yields removed the strong interest rate differentials favouring the U.S. dollar and as a result, the Euro, Pound and Yen rebounded. The DXY remains well above its level prior to this round of interest rate hikes.

Commodities

The S&P GSCI Index declined -1.34% in March. Energy commodities continued to re-normalise, as the dislocation and fears of a lack of supply due to the invasion of Ukraine drove the prices higher mid last year. Warm winters in both Europe and the U.S. helped reduce the demand for natural gas and thermal coal, allowing stockpiles to build back up. As can be seen in the chart below, the brent oil price is back to pre-Ukraine invasion prices.

Commodities were also hit by the fear of global slow down following the collapse of three regional banks in the U.S. and the “forced” acquisition of Credit Suisse by UBS in Europe. Concerns of a credit crunch driven recession that would reduce growth and demand globally weighed on commodities. Oil was quick to retreat on reduced global demand, but as can be seen in the chart below, rebounded quickly as the U.S. and Swiss governments reacted quickly to their banking challenges.