End of Quarter Review – June 2023

As fiscal year 2023 closes out, a review of the final quarter showed some notable highlights─the most significant of those being the sheer resilience of world equity markets in spite of encountering some very significant headwinds. This last quarter for fiscal 2023 was dominated by consistent interest rate hikes, a banking liquidity crisis, and a first quarter 2023 U.S. earnings season that was largely disappointing. In addition, the U.S. Federal Reserve, and the European Central bank amongst others signalled further hikes in the pipeline for the remainder of this calendar year.

The strength in equities was largely attributed to the U.S. economy exhibiting resilience and some pleasing inflation data indicating that the U.S. Federal Reserve was slowly but surely making progress in the fight against record high inflation. Another market driving force was the emergence of investor enthusiasm around large cap technology stocks and a sudden appetite to invest in the emerging artificial intelligence (AI) sector.

The MSCI All Country World Index gained 14.4% to 683 points for the fiscal year, the S&P 500 Index outperformed, rising 17.6% to 4,450 points, and China’s Shanghai Composite Index underperformed, losing 5.8% to 3,202 points. Domestically, the Australian S&P/ASX 200 Index lifted 9.7% to 7,203 points bolstered by positive gains across all sectors. The Information Technology and Utility sectors were the standouts for fiscal 2023— rallying an impressive 36.7% and 15.1% respectively.

On the commodities front, the majority of bulk commodity prices declined and are now close to pre-pandemic levels with quoted iron ore retreating 7% to US$112/tonne and Brent oil down 17% to US$75/barrel as a production cut by OPEC+ was offset by concerns over weakening demand from China. Gold finished the fiscal 2023 year higher, up 5% to US$1,912/ounce.

As widely anticipated, the Reserve Bank of Australia (RBA) raised its official cash rate at almost every monthly meeting during this fiscal year (except April 2023), taking the official cash rate from 0.85% at the end of fiscal year 2022 to 4.10% at the end of fiscal year 2023 in order to combat rising inflation. The RBA also indicated that “inflation in Australia has passed its peak, but at 7% is still too high” and “some further tightening of monetary policy may be required” to ensure that inflation returns to target range of between 2%-3%.

In this regard, the most recent underlying inflation rate eased to 6.6% in the March 2023 quarter from 6.9% in the December quarter. The labour market remained resilient with the unemployment rate of 3.6% in May and, we keep our calendar 2023 year-end unemployment rate forecast unchanged at 4.5%.That said, even at a 4.5% unemployment rate, the labour market is still considered to be at around ‘full employment’.

All up, with a strong labour market and population growth, capacity constraints across the housing sector, and additional fiscal support for household balance sheets, we forecast an end of calendar year 2023 underlying inflation rate of 6.2% and consequently, we expect two further official cash rate hikes in the coming months to take the cash rate to 4.60% by end of this calendar year.

Looking ahead, we now expect the world economy to expand by 2.3% in CY23 and then 2.0% in CY24. As regards the Australian economy, we forecast growth of 1.4% in both CY23 and CY24.

We expect a cautious investment environment for the global share markets in the second half of calendar 2023 as the dynamics of underlying inflation and the restrictive monetary policy transmissions from various central banks come into play.  Notably, the long and variable lags of the U.S. Federal Reserve’s tightening campaign may be catching up with the economy, but it is also clear that this cycle will be unique. Ultimately, we may see more of a rolling recession – implying that some sectors may be heading into downturn, while others are stabilising and rebounding.  In this regard, major central banks have singled their intention to remain vigilant and so far, despite an array of headwinds, global growth overall has continued to power forward.

Domestically, economic growth in Australia is forecast to gradually slow but we expect it to narrowly avoid a recession.  We note that while the inflation outlook continues to be ‘too high for too long’, and there are a number of upside and downside risks on economic growth, the risks seem to be more finely balanced now.

Against this background, the Australian share market is currently valued on a forward consensus price earnings ratio of 14.9x, which is 3% below the long-term average of 15.4x. The forward consensus dividend yield for the Australian share market is 4.2% (80% franked).

In our view, however, earnings forecasts are likely to face downward pressure in the coming months. We also view defensive stocks as likely to outperform cyclicals in an inflationary environment because these companies tend to benefit from pricing power, inflation-linked revenues and interest rate hedging strategies.

For the benefit of our clients, we would like to reiterate our ‘Champion Stocks’ which have a long term positive thematic over the coming years and, therefore, we are not particularly concerned about the current year’s investment arithmetic or the analyst’s twelve month buy-hold-sell rating. Our ‘Champion Stocks’ are: Amcor, Brambles, Challenger, CSL, Goodman Group, Lendlease Group, Netwealth Group, Sonic Healthcare, and Transurban Group.