Themes For June

The Australian share market closed out its financial year by returning 1.9% in June and a healthy 14.8% for the year, largely on the back of a strong resource sector which improved by 23%. The US market continued its impressive performance this year by returning 6.6% in June driven by strong demand for technology stocks associated with the boom in artificial intelligence. Other markets were mixed with Europe up 2%, the UK declining 1% while China was basically flat.

Bond markets were weaker as expectations for further increases in cash rates became mainstream thinking as inflation is proving more stubborn than policy makers anticipated last year. Australian 10-year bonds increased by 42bp to close at 4.03% following yet another 25bp rate hike by the RBA in June, while the US equivalent 10-year treasury bond yield increased by 18bp to close at 3.81%. Both the Australian and US yield curves are now inverted, meaning shorter dated yields exceed longer yields, a reliable indicator of a forthcoming recession. Commodity markets were stronger with oil 3.9% higher and iron ore up 7.2% which pushed the $A higher to close at 66.6 US cents.

Mid-Year Review

As we pass the mid-point of calendar 2023, it’s worth reflecting on market developments so far this year. The US market, as always, has been the global leader rebounding strongly from a tepid performance last year recording a rise of 16.9% with tech stocks even stronger, improving 32.3%. Our market has lagged the US, gaining 4.7% largely due to the lack of a robust technology sector. As reported last month, we are surprised at how resilient markets have been in the face of a steady flow of bad news. Inflation has proved stubbornly high and difficult to reduce, interest rates around the world have been aggressively hiked, the US narrowly averted a major banking crisis following the failure of several regional banks, the US federal government evaded a debt ceiling induced default and the war in Ukraine continues to grind on without any sign of resolution. In addition to this, expectations for company earnings have been consistently revised downwards through the course of the year based on expectations that economic growth will moderate due to the impact of restrictive policy over the past 12 months. In the absence of a material change to the economic landscape, it is difficult to see how the market can replicate its first half performance for the balance of this year.

The US is soon to commence reporting second quarter earnings with the market expecting a decline of 6.8% compared to last year which is 2.9% lower than at the beginning of the quarter, reflecting negative revisions from analysts. Based on these estimates, the US market is trading on a P/E multiple of 18.9 times, slightly above historical averages. While this valuation is not excessive, it is predicated on earnings that have been negatively revised for the past 4 quarters. Earnings for the third quarter are expected to be flat, however, there is an expectation of an 8% increase in the fourth quarter this year. This seems inconsistent with a deteriorating macroeconomic outlook (and possible recession) with the earnings recovery likely to be pushed out to Q1 or Q2 2024.



In the face of a supply shortage engineered by design during the pandemic, the decision by policy makers to radically stimulate demand will go down as one of the great errors this century. After failing to recognise rising inflation early in 2021, it is likely central banks will retain a hawkish stance and be prepared to risk inducing a recession to return inflation to their targeted levels.

Strategy and Outlook

We will retain a cautious approach to investment strategy for the foreseeable future. Our conclusion is that the market has run ahead of its fundamentals and is discounting good news that is unlikely to be achieved this year. While we have seen the peak in inflation, it is likely to prove very sticky due to the impact of catch-up wage increases pushing up unit labour costs – a major driver of inflation. While the second half of 2023 will be challenging, the patient investor is likely to be rewarded through 2024 when a better investment environment will emerge. Remember that markets are forward looking and will begin to discount better news long before it is reported. The confluence of stable (and possibly falling) interest rates combined with genuine profit growth will ultimately be positive for equity markets.

Gary Burke

Chief Investment Officer