November Review

A sharp revision to interest rate expectations saw a strong rally in the bond market which ignited an even stronger rally in global share markets, snapping a 3-month decline. The US market led the way by advancing 9.1%, while our market posted a lower but still healthy return of 5%. Other global markets recorded solid returns with Europe up 6.9% percent, the UK 2.3%, while China was more subdued rising by just 1.9% as it continues to struggle with its debt burden.

The catalyst for the bond market rally was data showing the rate of inflation beginning to moderate, raising expectations that interest rates have peaked and may possibly be cut by the middle of next year. US 10-year treasuries rallied by 63 basis points while Australian 10-year bonds improved by 52 basis points despite a surprise 25bp rate hike in early November.

Rising interest rates and stubbornly high inflation have been a major headwind for equity markets this year so any expectation that this may be moderating is a positive sign for share market valuations. While it is likely that the US Federal Reserve has finished hiking rates, it is not so clear cut in Australia. The new Reserve Bank Governor Michele Bullock has adopted a more hawkish tone, commenting that inflation here is no longer due to global factors but “home grown”, leaving open the possibility of a further rise in the new year.

In commodity markets, iron ore was 9.6% stronger and gold improved by 3.7% however weakness in the oil market saw brent crude fall by 4.9%. The widening interest rate differential with the US together with firmer commodity prices saw the Australian dollar improve by 4.7% to close at just over US 66 cents.

The benefits of global investment

Our multi-asset portfolios have long exhibited a structural bias towards international over Australian equities which has proved a successful strategy. Historically, international equity investment has generated higher returns with lower price volatility than Australian shares. This stands to reason as successful equity investment involves investment in world class businesses. While Australia has some excellent companies, our market lacks breadth and is heavily concentrated in resource companies and banks. The Australian market represents just 1.5% of world market capitalisation with a universe of just 200 major stocks compared to over 10,000 globally. Most innovative growth industries are only available in overseas markets (especially the US) such as technology (including artificial intelligence), pharmaceuticals, clean energy, electric vehicles, digital media, e-commerce, software etc. Successful stock selection in overseas markets has seen our international share portfolios outperform Australian shares by some 10% per annum over the last seven years which cumulatively equates to a 95% better return.

What about foreign exchange risk?

It is true that when you invest in overseas shares you also invest in the currency of the country you are investing in. Your investment return in this case represents both the movement in the share price of the company as well as the exchange rate to the Australian dollar. The USD is a particularly useful shock absorber in times of market stress as it is the world’s reserve currency and a safe haven in times of investment and economic uncertainty. A good example of this was during February/March 2020 at the outbreak of COVID where US shares fell by 27% however the AUD fell 17% against the USD offsetting much of the loss. Over the past ten years the AUD has depreciated from just over 90c to its current level of 65.6c against the USD which has greatly enhanced portfolio returns.

Strategy and Outlook

 While 2023 has been a turbulent year for financial markets, there are good reasons to look forward with optimism to the new year ahead. After a long struggle to tame inflation, it appears that central banks have been successful with clear signs of moderation. This has been a painful process involving 13 interest rate hikes in Australia which has increased the servicing burden of anyone carrying debt particularly mortgage holders. The conundrum for markets however is that the factors that will allow interest rates to be eased, i.e., slower economic growth, are not conducive to an acceleration in profit growth. Consensus earnings for US shares is still expecting growth of 12% in calendar year 2024 up from the 4% annual growth to November 2023. It is more likely that interest rate relief will provide a positive valuation effect for shares, however profit growth expectations will be pushed further out into 2025. Overall, the prospects for multi-asset portfolios look healthy as reasonable returns can be expected from shares as well as interest bearing securities especially fixed rate government and corporate bonds that directly benefit from lower interest rates.

Gary Burke

Chief Investment Officer

Level 6 / 360 Collins Street
Melbourne Victoria 3000
Phone 03 9959 9872
enquiries@boagfinancial.com.au

Boag Asset Management Pty Ltd
ABN 67 162 211 449
AFSL 469081
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