October Review

12 November 2024

Financial markets took a breather during October, largely consolidating the gains made so far this year. The broader US market edged 1% higher however the NASDAQ was up 3.1% due to the continued strong performance of large technology stocks. The Australian market was subdued, declining by 1.3% dragged down by a 5.1% fall in the resource sector, while China gave back some of its extraordinary gains from last month, declining by 5.6% as the market remains unconvinced about the success of its recent stimulatory measures. Europe largely followed the global pattern declining by around 3%.

There were significant moves in the bond market during the month as 10-year government bonds in Australia rose 53 basis points to 4.5% and US 10-year treasury notes increased 50 basis points to 4.3%. The catalyst for these moves is growing scepticism that central banks have been successful in putting the inflation genie back in the bottle.

Bulk commodities were weaker for the month led by iron ore which fell 5.1% on waning China sentiment however geopolitical uncertainty propelled the gold price 5.3% higher. Despite fundamentals suggesting the $A could strengthen due to a narrowing of the interest rate differential with the US, a stronger greenback saw the $A fall 5.6% to finish just under US 66 cents.

Trump win ignites markets

In the US Presidential election, the decisive victory of Donald Trump and a Republican clean sweep of both the Senate and (likely) the House has received a resounding endorsement from financial markets. Not only has the uncertainty of the electoral outcome been removed, control of all arms of government plus winning the popular vote gives the new administration a strong mandate to implement its pro-growth agenda involving tax cuts, regulatory relief and expanded domestic energy production. Of course, there are risks to this agenda, especially the potential for higher budget deficits and inflationary consequences of increased tariffs on China, however the potential for lower energy costs may mitigate the inflationary impact somewhat. In addition to this, the often-overlooked factor in the inflation equation is the supply side response. Improvements in productivity and efficiency from regulatory cuts and new technology can allow higher levels of non-inflationary growth. As the new administration only takes office on Jan 20 next year, at this stage the market can only speculate as to what will actually transpire.

Fed continues to cut but the RBA is on hold

The US Federal Reserve eased monetary policy by a further 25 basis points in early November following on from the 50-basis point cut in October. This move was largely expected as it would be unusual for there to be only one interest rate adjustment following a change in policy direction. Recent employment data and revisions printed weaker which gives the Fed enough justification to continue cutting rates for now. For this reason, it is likely there will be a further 25 basis point cut in December before the Fed pauses to re-evaluate their position. In Australia, headline inflation was within the RBA’s preferred band however this reflected the Federal government’s energy subsidies rather than a fall in structural inflation which will prevent any rate cuts until early 2025. The RBA held interest rates firm at 4.35% citing the ongoing inflationary pressure of government spending boosting public demand. The conundrum for central banks is that the data they are reviewing is lagging however the rate cuts only take effect with lead times of up to 12 months. The difficulty in balancing these two dynamics makes policy adjustment much more of an art than a science which to date central banks have navigated successfully.

Strategy and Outlook

In recent months, financial markets had entered somewhat of a holding pattern, however the US election outcome has changed the market’s psychology to now expect a much higher growth trajectory. While central banks were expecting a disinflationary economic slowdown, the market may now question this scenario. Profit expectations in the US were already buoyant with earnings growth forecasts for 2024 sitting at 9.3% improving to 15.1% in calendar 2025. In Australia, the earnings picture is not so rosy, largely reflecting the vastly different composition of our market especially the absence of a significant tech sector and a large mining sector whose earnings are captive to volatile commodity prices heavily linked to demand from China. Based on current earnings expectations, US market valuations are priced at around 21 times forecast earnings which is 15% higher than 10-year averages. While in the short-term, positive sentiment may push the market higher, it would not be a surprise to see a consolidation if not a minor correction at some stage in the next few months.

Gary Burke

Chief Investment Officer