Themes For July

Encouraging news on the inflation front propelled equity markets higher in July with the Australian market recording a healthy 3% return driven by solid contributions from the energy and banking sectors. Other world markets posted similar gains with the US up 3.4%, the UK 2.2% and Europe 1.3% stronger. China was the standout improving 10% based on expectations that the government is likely to use both fiscal and monetary measures to kick start their economy which has struggled since COVID restrictions were removed.

The US bond market weakened during the month with the US 10-year treasury yield increasing 14 basis points to 4% following yet another 25-basis point increase in the Fed funds rate. The failure by the US government to heed warnings about profligate deficit spending saw Fitch downgrade the credit rating for US sovereign debt. The US is now forecast to spend a staggering $780 billion per annum on servicing interest on accumulated debt in 2024, the largest non-military component of their annual budget. The Australian bond market was basically flat over the month to close at parity with the US as the RBA decided to hold rates steady to assess the economic impact of past rate increases.

Commodity markets were generally stronger particularly in the energy sector where oil was up 13%, thermal coal 7% while gold was 4.1% higher. The Australian dollar improved marginally against the US dollar advancing by 1.2% to close the month at just over US 67 cents.


Share markets are forward looking

While the impressive advance of major share markets so far in 2024 looks to be at odds with the prospects for the global economy, it’s worth remembering the share market is one of the most prominent forward-looking economic indicators. As we have reported in recent months, the trend in company earnings forecasts has been negative with analyst expectations being consistently revised downwards both in Australia and overseas. In addition to this, more than 12 months of interest rate increases by central banks together with higher bond yields are negative for both company profits and share market valuations.

The psychology of the share market however is to look forward to assess likely conditions in 12-18 months. Market performance this year combined with lower profit expectations has seen a rise in price to earnings ratios which usually indicates either an expectation of rising profits or lower interest rates. Many investors tend to be influenced by lagging economic data, that is data reflecting activity that’s already occurred, unemployment and inflation being major examples of this.

In Australia, strong demand for labour has pushed the unemployment rate to very low levels prompting concerns about higher wages pressures going forward. Ultimately the impact of tighter monetary policy by the RBA should produce a lower demand for labour meaning the unemployment rate should rise, albeit after the long and variable lags that apply to monetary policy. While the reported unemployment rate in Australia is very low, the following chart highlights that leading indicators are suggesting that future employment prospects are not as rosy which is good news for inflation and interest rates going forward.

Strategy and Outlook

Conflicting economic data readings often indicate that an economy is approaching a turning point. While the inflation fight is far from over, there has been significant progress in returning inflation to more acceptable levels. While we believe the share market ran ahead of its fundamentals in the June half, particularly by expecting rate cuts this year, there is no doubt the outlook for 2024 is much brighter. Interest rates and liquidity conditions will no longer be a headwind and the prospect of rising company profits will be the primary catalyst for share market performance next year.

Gary Burke

Chief Investment Officer