Local: The S&P/ASX 200 Index struggled in June. Rate hikes, recession fears, and rising inflation led to the benchmark index losing 8.9% of its value to finish at 6,568.1 points.
Global: The S&P 500 was down 8.39% in June, bringing its YTD return to -20.58%.
Gold: Spot price for Gold fell again in June to end the month at $1,806.
Iron Ore: Iron Ore prices fell sharply in June to US$122.5/Mt.
Oil: Brent Oil price fell significantly in June to reach US$109.03/bbl.
Housing: CoreLogic’s national Home Value Index (HVI) recorded a second consecutive month of value declines in June, down -0.6%, to be -0.2% lower over the June quarter. Continued falls in Sydney dwelling values (-1.6% month and -2.8% quarter) and Melbourne (-1.1% month and -1.8% quarter) were the primary drivers of this month’s steeper drop, but housing values were also down in Hobart (-0.2% month and -0.1% quarter) as well as regional Victoria (-0.1% month and +1.2% quarter).
CoreLogic Research Director, Tim Lawless, noted that housing value growth has been easing since moving through a peak in March last year, when early drivers of the slowdown included rising fixed term mortgage rates, an expiry of fiscal support, a trend towards lower consumer sentiment, affordability challenges and tighter credit conditions.
More recently, surging inflation and a rapidly rising cash rate have added further momentum to the downwards trend. Since the initial cash rate hike on May 5, most housing markets around the country have seen a sharper reduction in the rate of growth.
Interest Rates: The RBA Cash rate has recently seen 2 rate rises. A 0.5% rise in June coinciding with a 0.5% rise in early July. The cash rate is now sitting at 1.35%. The highest the cash rate has been since Q1 2019.
Retail Sales: Retail sales in Australia rose by 0.9% month-over-month to another record level of AUD 34.23 billion in May 2022, this was also the fifth straight month of growth, as the economy recovered further from COVID-19 disruptions. Department stores had the largest rise (5.1% vs -2.5% in April), followed by cafes, restaurants, and takeaway food services (1.8% vs 3.3%).
Bond Yields: Australian government 10-year bond continued to rise in June to finish the month at 3.57%. The US 10-year bond also rose slightly to 2.97%.
Exchange Rate: In June the Aussie dollar fell slightly against the American dollar, at $0.689, and remained stable against the Euro at $0.664.
Inflation: The annual inflation rate is currently sitting at 5.1% based on the March 2022 quarter. With headline inflation expected to peak around the 6% y/y mark by Q3 2022.
Consumer Confidence: The Westpac-Melbourne Institute Index of Consumer Sentiment fell by 4.5% to 86.4 in June from 90.4 in May. Over the 46-year history of the survey, we have only seen Index reads at or below this level during major economic dislocations. The record lows have been during COVID-19 (75.6); the Global Financial Crisis (79.0); early 1990s recession (64.6); the mid-1980s slowdown (78.7) and the early 1980s recession (75.5). Those last three episodes were associated with high inflation; rising interest rates; and a contracting economy – a mix that may be threatening to repeat.
Employment: The seasonally adjusted unemployment rate remained at 3.9 per cent in May 2022. Seasonally adjusted employment increased by 61,000 people (0.5 per cent) in May 2022.
US Employment: Total nonfarm payroll employment rose by 372,000 in June, and the unemployment rate remained at 3.6 percent. Notable job gains occurred in professional and business services, leisure and hospitality, and health care.
Purchasing Managers Index: The Australian Industry Group Australian Performance of Manufacturing Index (Australian PMI®) rose by 1.6 points to 54.0 points in June 2022 (seasonally adjusted), indicating mild growth. The indicator has been in expansion since February 2022. Results above 50 points indicate expansion, with higher results indicating a faster rate of expansion.
Sources: ABS, AFR, AWE, BLS, CoreLogic, RBA, TradingEconomics, UBS, Westpac
Year in Review
An initially strong first half…
The global economy started FY22 exceptionally strong, although momentum subsequently slowed as resurgent Covid variants and ensuing lockdowns weighed on the recovery. Nevertheless, the underlying story of the first half of the financial year was one of continued economic growth, albeit at a more normalised pace.
Was overshadowed by a surge in inflation…
However, surging consumer demand combined with pandemic-induced supply side bottlenecks triggered a global supply chain crisis late in 2021. Concurrently, soaring energy prices, particularly in Europe and China, caused an energy crunch. This resulted in the biggest surge in inflation in decades.
Which central banks then scrambled to tame…
The surge in inflation was initially expected to be ‘transitory’. However, this proved to be mistaken, with inflation proving to be higher and stickier than previously believed. This saw central banks fall ‘behind the curve’ and they were forced to raise rates more sharply and earlier than initially anticipated in an attempt to bring inflation under control in the second half of the financial year.
Slowing the economy…
Sharply rising interest rates, as well as the impact of high inflation, began to slow the economy markedly in the last six months of the financial year. US Q1 22 real GDP contracted for the first time since the pandemic. Consumer confidence plunged as high inflation eroded real incomes. A further hit to the global economy came from the Russian invasion of Ukraine in February, which sparked another sharp rise in energy-related commodity prices and consumer energy bills.
& raising the risk of recession.
Markets became increasingly concerned that central banks would raise rates so sharply to fight inflation that the economy would fall into a ‘hard landing’ or recession. Underscoring this was repeated statements by US Federal Reserve Chair Jay Powell that the Fed would do whatever it takes to tame inflation. The bond market appeared to be increasingly pricing in this risk, with the yield curve inverting (an event that has historically preceded recessions) in April.
China’s economy takes a hit from COVID
The Chinese economy was a laggard as it dealt with the impact of stringent lockdowns stemming from the government’s “zero COVID” policy, which resulted in shutdowns of major manufacturing centres. The Chinese authorities responded with various stimulus measures to boost the economy.
Australian economy strong but cracks appear…
The Australian economy performed well over FY22 and maintained momentum towards the end of the financial year. However, the economy was beginning to face a myriad of capacity constraints and inflation began surging albeit less so than overseas. Cracks began to appear in the previously red-hot housing market as rising mortgage rates, worsening affordability and deteriorating consumer sentiment took a toll. Dwelling prices rose 8.4% over FY22 according to CoreLogic although prices had already begun to fall from their peaks, led by Sydney and Melbourne.
As the RBA pivots from dovish to hawkish
The RBA abruptly pivoted from saying in October that rates would not go up until 2024 to then raising rates by 25 basis points in May (its first rate hike since 2010), a 50 basis point rise in June followed by a further 50 basis point rise in July.
A ‘tale of two halves’ for equities
Global equities initially rallied for the first six months of the financial year and hit record highs around calendar year end. However, the last six months of the financial year saw equities hit by valuation compression due to sharply rising bond yields followed by concerns that central bank tightening might cause a recession. The S&P500 index at one point fell 24% from its early January all-time high, putting it firmly in ‘bear market’ territory. Consequently, global equities posted their worst 1H (1st January to 30th June) return since 1970.
Most equity markets post negative returns…
Over FY22 global equities posted a total return of -15.4% in US$ (-7.6% in AU$). Most major markets posted double-digit losses with the UK FTSE 100 (due to its exposure to oil stocks) and Japan TOPIX (due to a falling Yen boosting exporters) notable exceptions. However, given the strength of the US$, in common currency terms the S&P 500 was the strongest performing major market (-2.4% total return in AU$). Chinese equities were a major underperformer as the Chinese economy was impacted by COVID lockdowns.
As valuations come under pressure from rising rates.
The overwhelming driver of equity market weakness was falling valuations, which were in turn weighed down by rising bond yields. The S&P 500 and ASX 200 indices saw their forward P/E multiples fall 26% and 29% respectively over FY22 while earnings rose over the same period. Consequently, US equities are currently trading near their 20-year average P/E while Australian equities are currently trading slightly below.
Source: MWM Research
Vanguard Market Outlook
Market Returns are anything but average
With the recent release of the 2021 census, we have learned that the average Australian is “a female aged 30-39 years, living in a coupled family with children, in a greater capital city area, with an average weekly family income of $3,000 or more”. Average market returns can be seen as deceptive. This is because it is highly unlikely that any one year will deliver an average market return, which presents a challenge when we are trying to steer investors as to how markets might behave in the future.
S&P ASX 300 Total Return index performance (% p.a.) Calendar years 1990-2021
Past performance is not a reliable indicator of future results. Source: Morningstar, Vanguard calculations. Notes: S&P/ASX 300 Total Return, 1 January 1990 to 31 December 2021.
As you can see from the above graph, markets often don’t achieve anything approaching the average return of 10.6%. In fact, it was more than +/-10 percentage points away from this long-term average 60% of the time. Furthermore, it only came within +/-5 percentage points 37% of the time. If anything, what the chart underlines is just how volatile the markets can be – that is, just how much shares tend to bounce around their long-term averages from one year to the next. Returns of 17.5% for the year ended December 2021, and even with a 20% decline at the commencement of the Covid pandemic, an 8.8% annualised return was achieved for the five years ending December 2020.
Markets do not move in straight lines
In general, simply extrapolating future results from past performance is not a good idea. It is why we favour a more strategic approach to investing with low-cost funds and an asset allocation that represents peoples individual goals. With different regions around the world offering different opportunities, it is also important that investors follow a globally diversified approach to exploit these opportunities and offset the potential for some investments not to perform as expected. All asset classes will jump around in the short-term but over the long-term shares tend to return more than bonds and bonds more than cash.