Themes For August

The rally in financial markets in July appears to have been a false dawn based on the misguided narrative that inflation was moderating, and that monetary policy may not be as restrictive as previously thought. During August, these expectations were dashed as central banks continued to tighten policy and reaffirmed their commitment to squeeze inflationary pressures out of the system no matter how severe the economic consequences.

The US market fell 4.2% which mirrored falls in other global markets, however, Australia fared better improving by 1.2% due to a strong energy sector as well as a solid profit reporting season.

Bond markets gave back their recent gains with the US 10-year treasury note closing 49bp higher at 3.2% and the Australian 10-year bond up 54bp to 3.7%.

Commodity markets continued to weaken particularly crude oil which fell 13%, iron ore was down 2.3% however once again natural gas proved to be the exception increasing by 9.6% on growing concerns in Europe of supply restrictions from Russia.

The Australian dollar responded to the risk-off environment by falling 2% to close at just over 68 US cents.



Investment Outlook

The next few months are going to be difficult for financial markets as they cope with tightening monetary policy and uncertainty about the economic outlook. While earnings results have held up well to date, particularly in Australia, the expectation is that revisions will be negative in the next two quarters which will place pressure on equity valuations. Adding to the uncertainty are threats by Russia to cut off natural gas supply to Europe as they approach winter, together with continuing manufacturing disruptions in China who persist with rolling lockdowns as part of their zero COVID policy. This is a period where investors need to be patient and stick to a long-term investment strategy. Our strategic approach to asset allocation is based on long-term forecasts of the fundamentals that are proven to drive financial market returns. We will only take on additional equity risk when we feel we will be adequately compensated by additional return. The likelihood is that monetary policy will have to remain tighter for longer to achieve the desired inflationary outcome which is problematic for both earnings and valuations. The catalyst for increasing the equity risk in multi-asset portfolios will be when earnings revisions have stabilised which is likely to be in early 2023.