The month that was...

The RBA has continued to deliver what the central bank itself said just 12 months ago would never happen, increasing interest rates by 50 basis points in July and August. Despite Australia being among the most sensitive economies to movements in interest rates and bond yields, the cash rate has now moved to 1.85 per cent, seeing a near doubling in mortgage repayments for those who borrowed in 2020 and 2021.

It remains to be seen what impact the ‘wealth effect’ will have, that being changes in consumption habits when the value of your largest asset, your home, reduces. Historically, this has led to a contraction in spending, the slowdown in the economy and higher unemployment. The RBA is predicting an increase in unemployment in 2022 which to many seems counterintuitive, slowing the economy, and sending people out of work to fight inflation that is being driven primarily by global factors.

The industry super fund sector has ridden a wave of falling bond yields for the last decade, with large allocations to private assets like direct property, private equity and infrastructure benefitting from ever higher valuations. It has been a similar case in venture capital, where companies tend to be valued at their last ‘raising’ price rather than a comparable market valuation. The fact that these funds with massive unlisted assets were able to report financial year returns just a few days after the end of the year likely came as a surprise to many.

This is particularly so given the news in the weeks that followed the popular technology unicorn Canva, which has driven venture capital returns in Australia for years, had been devalued by as much as 30 per cent based on the fall in the value of similar companies in the Nasdaq. This puts funds in a difficult position with those contributing before the revaluation essentially buying an asset at an inflated price.

It was all about equities in July, with the local market rallying around 6 per cent despite fund manager sentiment turning the most negative in decades. The rally was essentially driven by a reversal in bond yields, which supported the technology, financial and property sectors to near double-digit gains. Markets are always quick to both price and reprice events as they occur, with a growing consensus that rate hikes cannot be increased as much as currently predicted by traders in the market. The standout was the smaller companies sector, benefitting from a return of risk-taking, with the local market now sitting less than 10 per cent below the highs reached in January, due primarily to Australia’s unique resource and material-dominated benchmarks.

It was a similar story in the US, with another reporting season billed as ‘the most important in years’ exceeding expectations; albeit lowered expectations following negative commentary thus far in 2022. The Nasdaq lead the way gaining 12 per cent with the technology sector finally seeing some light at the end of the tunnel. The S&P500 and Dow Jones underperformed, primarily due to the larger weighting to traditional energy and consumer businesses. Over half of the 56 per cent of S&P500 businesses that had reported to the time of writing had beaten expectations, which while lower than average, was much better than originally feared given the threat of inflation and higher costs across the supply chain.

The Labor Government has finally had its first day back in Parliament with a swathe of changes quickly enacted. The construction commission was first to be removed, with an indigenous voice, climate policy and economic reforms set to follow. It is clear the party will be pushing forward with a strong mandate on climate following the massive swing in votes to the Greens and independents, but there are clear challenges facing an economy that is still recovering from the pandemic. Immigration, long the driver of economic growth remains weak, while Australia’s reliance on commodities is unlikely to change for the foreseeable future despite significant investment earmarked for renewable energy assets.

The headlines have clearly been hyperbole, however, the unthinkable is beginning to occur with property prices across the eastern seaboard starting to fall. The pullback, which by all reports was around 2 per cent in July, offers a clear reminder of the key role that interest rates and bond yields have played in the valuation of every asset class in Australia and around the world. The idea that property values always increase will likely be challenged in the short to medium term, as credit growth slows and borrowing capacity reduces. That doesn’t necessarily mean a collapse is on the cards, actually quite the opposite. Should construction of new housing slow and immigration recover, the shortage of property that has existed for a decade is unlikely to be reversed. That said, there will no doubt be significant pain in the months and year ahead particularly for those with large mortgages and multiple properties.

Corporate activity has slowed in the technology and growth sectors but remains alive and well elsewhere in the market. ANZ garnered the headlines after simultaneously lobbying bids for both accounting platform MYOB and Suncorp’s banking division. The success of the latter meant the former was quickly placed on the back burner, but many analysts are questioning the purchase.

ANZ has lost market share and struggled to make loans as efficiently as CBA and NAB, with this deal essentially buying back lost market share. Ramsay Healthcare remains in a holding pattern as the company’s private equity suitor struggled to undertake due diligence on it’s European assets.