The March 2023 quarter started with investor confidence riding high through January amid expectations inflation had peaked and central banks would avoid a hard economic landing. Then in the month of February, a spate of conflicting economic data showed inflation had flat-lined, exasperating market confidence, and causing investors to hit the brakes hard. The S&P 500 fell more than 2.5% in February, and has since been dominated by volatility and uncertainty. While the U.S. Federal Reserve’s dilemma on how to tame inflation without crippling the labour market seems to have become a market obsession in recent months, further pressures emerged in March as investors were spooked by liquidity concerns within the banking system. What followed was a string of regional bank failures in the U.S. which further spread to Europe, leading to the fall and eventual sale of one of the continent’s largest financial institutions─ Credit Suisse Group AG.
Nevertheless, the global share markets displayed surprising resilience against all odds and most finished the quarter higher.
The MSCI All Country World Index climbed 6.8% to 647 points for the quarter, China’s Shanghai Composite Index lifted 5.9% to 3,273 points and the S&P 500 index finished the quarter an impressive 7.0% higher at 4,109 points. The Australian S&P/ASX 200 Index underperformed, rising only 2.0% to 7,178 points for the quarter after falling to a low of 6,898 points on 20th March. Domestically, the Consumer Discretionary and Information Technology sectors were the standouts— rallying 9.9% and 7.5% respectively. The most significant fall of the quarter came in the Energy sector, which was down 5.3% mainly as a result of a sharp sell-off in energy companies globally on the back of the energy crisis and restrained demand.
The Australian share market was focused on the profit reporting season in February with the number of earnings beats and misses evenly balanced. Some of the well-received results included companies that exhibited strong trading conditions like Goodman Group, Sonic Healthcare, QBE Insurance Group as well as Brambles, Woolworths, and Telstra Group where the ability to pass on increasing costs drove outperformance.
In commodities, the quoted iron ore price strengthened 8% to US$127 per tonne. Gold rose almost 9% over the quarter to US$1,980/oz buoyed mainly by its appeal as a ‘safe haven’. The Brent oil price finished the quarter lower, down 7% to US$80 per barrel partly as supply constraints, the Russia-Ukraine war, and renewed Chinese demand pulled and pushed the price.
Following a 0.7% expansion in the September 2022 quarter, the Australian economy expanded a further 0.5% in the December 2022 quarter, supported by strong household spending. On an annualised basis, GDP was up 2.7%, supported by growth in domestic demand and strong net exports. However, we forecast GDP growth of only 1.4% in calendar 2023 as the Australian economy slows given the headwinds on private consumption from higher net interest payments and cost of living pressures.
Cost of living continued to climb with the most recent underlying inflation rate of 1.7% in the December 2022 quarter─ accelerating sharply to 6.9% on a year-on-year basis (the highest since 1990). This sharp increase was primarily caused by stubbornly higher services and goods inflation.
With inflation persistently too high during the quarter, the RBA raised its official cash rate twice by 25 basis points, taking the cash rate from 3.10% at the end of December 2022 to a 10-year high of 3.60% by the end of March 2023. The RBA has recently indicated that “inflation has peaked in Australia but the path to achieving a soft landing remains a narrow one”. As such, the RBA forecasts inflation to decline for the remainder of 2023 and thereafter to be around 3% by mid-2025. We now forecast a peak cash rate of 3.85% over the coming months before it drops back to 2.85% by the end of calendar 2024 as inflation cools.
Despite the backdrop of a global energy crisis, cost-of-living pressures, and high interest rates, we believe that odds of a severe global recession have declined, but a mild recession still remains a distinct possibility. We expect the world economy to expand by only 2.2% in CY23 and then 2.5% in CY24. As regards the Australian economy, we forecast slower growth of 1.4% both in CY23 and CY24.
Share market outlook
The Australian share market is currently valued on a forward consensus price earnings ratio of 14.1x, which is 8% below the long term average of 15.4x. The forward consensus dividend yield for the Australian share market is an attractive 4.4% (80% franked).
We think the current economic environment poses significant challenges for central banks. On one hand, inflationary pressures are likely to require these banks to prolong a tight monetary policy. While on the other hand, prolonged higher interest rates will place stress on some segments of the financial system (as evidenced by the recent banking system liquidity concerns).
While the situation remains fluid and uncertain, it’s worth noting that the banking systems in developed countries are well-regulated and capitalised, and the response from policymakers thus far has been well-measured and controlled. We therefore expect these strains to gradually recede later this year with relatively modest effects on economic activity. Against this backdrop, we expect the U.S. Federal Reserve, as well as other central banks, to continue to closely monitor and tighten monetary policy in the quest to return inflation to a downward trajectory.
All up, we still envision a series of “rolling” country level recessions throughout the year including downturns in the euro area, US, Canada, UK, and Russia—among others. Therefore, earnings forecasts are likely to face downward pressure in the coming months and we view defensive stocks as likely to outperform cyclicals in an inflationary environment with these companies likely to benefit from inflation-linked revenues and interest rate hedging strategies.
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.
For those investors looking to gain exposure in the global share markets, we have recently produced two international investor reports titled, ‘Our Buy Rated U.S. Stocks’ that identify our preferred large cap U.S. stocks that we particularly like for private clients. The first report includes three large cap companies with an agricultural theme─ Corteva, Deere & Company, and Tractor Supply Company. The second report has just been released and identifies one large cap life science tools and diagnostics company called Bruker Corporation which is a leading provider of instrument, consumable, and service solutions for the life science and diagnostics industries worldwide.