The Month That Was...

Just when it looked like the market selloff was complete and investors had fully ‘repriced’ businesses based on a significantly higher bond yield and cost of capital, volatility shifted into another gear in June. Even those sectors that had performed well thus far in 2022, being energy and materials reversed gains, the former only modestly, down 0.3 per cent, and the latter more than 12 per cent.

This hides the significant run-up and then a reversal in the energy sector mid-month. Typically, the monthly ‘winners’ are those with the largest gains, but in this case just remaining flat, which consumer staples managed, was enough to outperform the market by close to 10 per cent.

Five of the ASX’s eleven sectors fell by more than 10 per cent with the traditional ‘rotation’ into defensive sectors including healthcare, consumer staples and telecommunications on show again given the relative strength of cash flow and earnings of these businesses.

It was a similar story overseas, with the Dow Jones 30 component index falling just 6.7 per cent, but the Nasdaq continued the recent selloff, falling by double figures again ahead of what is likely to be an extremely challenging reporting season. Currency has been an important factor with both the Nikkei, FTSE and ASX all outperforming as their currencies weakened.

Over the year, the dispersion in returns was incredible, with the S&P/ASX200 falling 10.2 per cent, the third negative financial year return in a decade. Utilities and energy outperformed amid the global energy crisis, gaining 29.7 and 25.1 per cent, with technology down 38 per cent and retailers 21/8 per cent.

Woodside topped the tables for large caps, gaining 58 per cent, while NAB outperformed Westpac and ANZ by more than 20 per cent. Tech and profitless companies were hardest hit, with Zip Co, Marley Spoon and Booktopia all down more than 90 per cent. 

The event that started it all was seen by many as unlikely to occur, or not worth taking action on according to many experts. The Reserve Bank seemingly unexpectedly increased the cash rate by 50 basis points in June, after a 25-basis point hike in May, which sent the 10-year bond yield ahead of the US and beyond 4 per cent. The result has been a disastrous period for long-duration bond investors, but in the long-term, a positive for retirees as higher interest rates make lower-risk investments ‘investable’ once again. There are signs that the market doesn’t believe the RBA will get rates as high as forecast, with the bond yield starting to taper towards the end of the month.

One of the sectors most impacted by increasing interest rates is property, which has just fallen for the second straight month. The impact occurs on multiple levels, the first is the weakening of sentiment and lower confidence of buyers to go out and bid, but also the lesser availability and higher cost of lending. There are predictions, not unlike in 2020, of a 30 per cent fall in property prices, which may well be possible if the RBA followed through on every planned hike, but that now seems increasingly unlikely. Commenting and questioning the RBA’s decisions during the pandemic has become somewhat of a pastime, yet one of their most important roles is providing confidence to the economy and all its participants, something it clearly achieved during the pandemic. 

There is a tendency in markets for momentum to drive investment decisions even at the professional level. Think forecasts of another commodity super cycle, secular rather than cyclical growth in tech, or the instability and then un invest-ability of China in a short period of time. Commodities and energy have been beneficiaries of the latest of this momentum with many portfolios now overweight both sectors even as signs of a peak begin to grow. This month saw the copper price hit a 17-month low, despite the expected supply shortfall, lithium tanked significantly on supply concerns and oil quickly retreat towards a bear market as the old saying was proven true once again. That being ‘solution to higher prices is higher prices’ as demand destruction begins in earnest.

On the positive side, outside of geopolitical pressure and expansion into the Pacific, China is re-emerging on the global stage. The end of lockdowns in Shanghai and Beijing have once again greased the wheels of global trade, the majority of which still relies on China despite commentary around ‘re-shoring’. The government has responded by offering greater access to credit, reducing regulation, and offering tax cuts in an effort to bounce back from a difficult period for the economy.

Closer to home Australia is in the midst of a significant energy crisis, clearly with many parties and stakeholders contributing to the issue in one way or another. At the centre of the challenge are Australian companies like Origin, who are able to export gas at prices three times higher than domestic levels to countries in dire need, but who are being encouraged to keep this supply in the domestic market. The government took control of the market as coal-fired plants stepped out due to the cost and inability to access supplies, with the threat of blackouts likely to continue through winter. 

The recession risk is real, particularly if the ‘confession season’ before reporting season proper is anything to go by. The list of downgrades grows longer and this month included Evolution Mining, OZ Minerals, Bed Bath & Beyond, Origin, and Healius. On the positive side were Vicinity and Collins Foods, benefitting from a recovery in retail trade.