Quarterly Market Update – Q3 2023

June Quarter 2023

Market and Asset Class Views


Jay Powell and the deferral of destiny

We have spent the last quarter observing market pundits calling out an immediate major softening in global economic conditions. As rates have ramped up in all Developed Economies, surely the price to pay was weaker economic growth? Despite the impending doom, equity markets have made substantial gains led by the US. This gain is also surprising given treasury markets have stepped back from forecasting an immediate exercising of the “Powell Put” and falling rates but have now started to bake in a higher-for-longer interest rate outlook.

We do expect a downturn in equity markets – something will get broken – timing and magnitude unknown, but not yet. Importantly, excess liquidity is underpinning risk markets, and this will continue in the short term – i.e., for the next quarter. But the higher rates go, the more certainty we have that something will break in risk markets. We have become inveterate watchers of 2 indicators – inflation and unemployment. Perhaps market liquidity is the best indicator of impending “breakage”?

In the big picture calls, we look to take some risk exposure out of Equity markets and dial into longer duration Treasury and Corporate investment grade Bonds and Alternatives.

Australian Equities: After leaning in – we now lean-out…a bit.

Our last call on Australian Equities was to “lean in a little”. It proved to be a good call, but we should have leant in a little more.

As noted in our previous quarterly, the Australian market remains one of the cleaner stories globally. We have both trade and fiscal surpluses, relatively free from geo-political risk, political stability and a more benevolent inflation, interest rate and economic growth mix. The dark cloud on the economic front, is the China dynamic. This variable will drive relative over or underperformance in Australian markets. Commodity markets are pinning their hopes on a major stimulus. If it happens, it will be a sugar hit for equities, but its duration will be limited.

Sector specific, we retain an overweight to Commodities (option on China and inflation), underweight consumer facing financials and Discretionary retail. We also remain overweight more defensive sectors such as Healthcare, Infrastructure and Consumer Staples.

We expect the ASX 200 to remain range bound and are happy to tilt longer on pullbacks in the 7000 range and lighten at the top of the range i.e., above 7400.

Our preferred equity exposure – but move back to Neutral.

US Equities – Bubble, Bubble Toil and (AI) Trouble?

Indeed, it was a strong quarter with the S&P 500 Total return index generating +8.3%. One of the major concerns has been the lack of breadth in this US market rally. June did see a wider participation, however the heavy lifting since Xmas has been in the AI/FANGS/Magnificent 7 thematic. Further illustration on the market lop-sidedness is in the US Small Cap sector running at a 20% discount to the Large Caps on price and a 50% discount on valuation (Goldmans).

The US consumer is remarkably resilient, but we all have underestimated 1. How much accumulated savings had been built up over Covid 2. robust employment market 3. robust Housing market (no-one wants to move). 4. partial QT reversal with liquidity being pumped in to stabilise the banking sector over the quarter.

Forward indicators are starting to weaken, but not to the point where the Fed will halt their tightening cycle. The Fed still faces Buoyant Property, Equity and Employment markets. 

One of the market’s favourite maxims is “Don’t fight the Fed” – yet the Equity market is doing just that. The US stock market trades on 19X forward PE earnings on this is on the back of PE multiple expansion than real earnings increases. Analysts have a baked-in 12% earnings growth over the next 12 months. The market yield earning lower than bonds and certainly cash at 5%.

We won’t get the timing right and the momentum trade is seductive, but we start now and in a disciplined fashion, our preference here is for the following portfolio adjustments.

  1. Lighten outright US exposure. (weighted towards the end of the quarter)
  2. Some rebalancing from large cap weightings into Equal weighted vehicles.
  3. Some rebalancing from large cap into small cap exposures.

The risk of a correction – whether fast or slow – is now higher. We move to Mild Underweight.

EU Equities – Still cheap – and it will get cheaper.

A flat quarter for European equities with the market returning +0.89% but saw the 12 months return still healthy at +13.46%

The Euro is facing a tightening cycle almost as steep as the US, but with far less economic capacity and flexibility to accommodate. We cannot see how the EU provides a more attractive proposition than other markets. It thematic as a “value” play has now passed as the baton is past back to the Growth story represented through AI. It is likely that the EU will be an accelerated version of the US, i.e., tightened later but will cut sooner.

The biggest economy, Germany, is now in a technical recession. The question is will that spread to other EU countries. In analysing Germany in isolation there 3 things to know 1. It outsourced its defence to the US 2. Outsourced its Energy policy to Russia and 3. Outsourced its Economic Growth to China. Of course, you could substitute Australia for 2 of these.

Whilst the EU is still cheap to the US, it’s for a very good reason. We move to Underweight.

EM Equities – it’s all about China (again)

Déjà vu – As discussed earlier, China still looms as the big unknown. The anticipated major domestic economic lift due to the reopening trade has been disappointing. GDP forecasts, PMI’s, PPI’s continue to be lowered, interest rates are being cut however the spectre of a Taiwan invasion has receded. The market is anticipating a classic Chinese policy response (big centrally driven spend in Infrastructure etc) and, when delivered, will give markets a shot in the arm. However, China’s structural problems such as Property remain unresolved and its major trading partners are slowly falling (or have fallen) into recession territory.

Counteracting this partially is a more robust Japan. Though not an EM economy itself, its linkages to the rest of Asia remain important. This will not be enough for us to gain our confidence to reweight.

EM outlook will be dominated by China. With such uncertainty we reduce our weighting to Negative.

Property – Value starting to build – but in the Australian listed space.

We need here to delineate between Private Commercial Real Estate (CRE) markets and it’s listed sibling. The view here is that, over the next quarter or two, we will continue to see pressure on revaluations and liquidity in both private and public portfolios. The difference here is that the Publicly listed space has already seen a heavy discounting in equity values and many places remains “cheap” especially on a “cost to replace” basis.

Recent US Bank stress testing showed that small and mid-sized banks hold some 80% of Bank held CRE exposure. They have been tightening their lending criteria substantially as Interest Coverage ratios get pressured by rising rates. Anecdotal evidence suggest Australian banks are doing the same.

We retain a Neutral Property with a strong preference for AREITs over IREITs but would be underweight Unlisted vehicles in both geographies for the next six months.


Gold Small trinket buying.          

Gold has played its role over the 12 months but has given back a bit in performance this quarter. Rising real rates coupled with a stronger USD have been the main cause. Gold remains s a core part of uncorrelated asset holdings. Given the recent pullback we increase our allocation.

Hedge FundsDriving the right vehicle.

For a longer investment horizon, we have a continued preference for real asset funds, agricultural, timber, commodity etc. Trend following funds have had a good run of late but as we see markets breaking down later in the quarter we look to lighten. Global Macro should continue to perform.

Infrastructure – Crowded Trade?

We continue to see strong preference to investing here. Buyers have a range of reasons (CPI linked inflation hedge, Defensive Qualities in Asset portfolios, usually have real tangible assets. We continue to look to allocate at SAA levels.

Private Equity It’s still equity.

Much has been written about the impasse between listed equity markets and private equity and their respective valuations. As the private space continues to grow at the expense of public, this is forming a key part of the premium and may be justified. We revert to Neutral from underweight and allocate at SAA targets.

Fixed Income:

Government Credit – bonds are back in town

We increase our allocation to quality Fixed income. We are now rewarded on an out-right risk-free yields of 4.0% for most of the curve, both here and Australia.

Whilst remaining in cash produces a similar yield in the short term, if we see inflation fall there will be a quick adjustment in yields across the curve back to 3.25%. To support this view, we must believe that inflation has peaked, but the attraction is resultant capital gains on bonds will also and adding to the out-right yield return, some 10% +.

We will get more aggressive when the data validates our view. The running yield and

We favourable lift our government bond allocation by 0.5+ to +1

Credit: Credit where credit is due.

We expect some bifurcation in US credit markets where.

  • Weaker credits will start to face a refinancing wall as fixed rates obtained during Covid are now required to be rolled over at much higher rates. Floating rates are likely to remain higher, for longer, putting more strain on borrower balance sheets. A tepid economy and tighter bank lending standards won’t help.
  • Investment Grade (IG) credits should remain in good shape. Most here have market pricing power in passing through costs and access to equity markets. Also, most are fixed rate, so a long duration profile will assist or view.

Similar story for Australia, however here we are more discerning/granular in our view.

  • Real Estate Debt secured by first mortgage has the right combination of return, realistic valuations and covenants.
  • RMBS books will need monitoring as retail mortgages become stressed.
  • Corporate debt will follow the same themes as per the US above.
  • Consumer Debt will also require monitoring with the employment rate being the macro variable to watch.

We retain our Neutral call on Credit, +ve for IG and -ve for Sub Prime.

For further information and guidance, please contact us here.

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