OnePath WS-Sustainable Inv Aus Shares (MMF0335AU) Report & Performance

Equity markets rose in June, continuing to defy expectations throughout 2023 as expectations of a paradigm shift in AI drove tech stocks even higher and bond yields stabilised as inflation fell from peak levels. Australia’s S&P/ASX 300 Index delivered a 1% return over the June quarter including dividends, underperforming both the MSCI World (+6.8%) and the US S&P 500 (+8.8%). Australia’s lower exposure to tech stocks and greater reliance on China for its exports led to relative underperformance, and was further exacerbated by huge outperformance within the US megacaps tech stocks.

The slowing Chinese economy weighed on its sharemarket, with the Shanghai Composite falling 6.9% in AUD terms, contributing to weaker performance in Emerging Markets. Sector performance in Australia was led by Tech (+18%), Utilities (+4%) and Energy (+3.8%) while Healthcare (-3.1%), Materials (-2.7%) and Consumer Discretionary (-1.9%) were the laggards. Despite a rebound in the miners and in some commodity prices in June, this wasn’t enough to make up for sharper falls earlier in the quarter. Iron ore fell 11% to USD108 over the quarter, yet rebounded 10% last month on hopes China stimulus will ignite growth, although measures such a 10bp rate cut and EV subsidies have thus far been insufficient.

Oil prices fell 6% over the quarter to USD71/bbl. Bond yields have traded in a narrow 50bps range this year, with US bond yields at 3.83%, only 4bps lower than where they started the year at 3.87%. Consumer confidence in the US rebounded sharply, helped by signs that inflation is cooling and a willingness for people to continue spending if still employed.

The spending shift from goods to services there continued with the travel industry still reaping the benefits of pent-up demand for holidays post Covid, although here the Australian consumer outlook painted a less rosy picture, with cost of living pressures and higher mortgage rates hurting the domestic retail sector. After lifting rates in May and June, the RBA kept rates on hold at 4.1% at the start of July, the second pause since this rate cycle started and possibly an acknowledgment that 13 months of hikes is helping to reign in spending and cool inflation.

Equity markets shrugged off risks of a credit crunch amid further US regional bank failures, and continued to strengthen in April, with Australia’s S&P/ASX 300 index closing up 1.85% including dividends. Global markets have rallied this year despite recession fears, although market breadth has been worryingly narrow in the US, with two stocks (Apple and Microsoft) now accounting for 13% of the entire US S&P 500 index. The MSCI World Index gained 2.9% in AUD terms, and has risen 12.3% year-to-date, driven by a strong rebound in Europe and 7 mega-cap Tech stocks doing the heavy lifting, and contributing over 90% of the US performance.

The only blemish on Australia’s performance in April was weakness in mining stocks. BHP fell 5.8%, capping off a month to forget in the Materials, the sector falling 2.6% and the only sector to lose value in April. Iron prices came off lofty levels, falling 12% to $US106 per tonne as China demand softened and inventory levels rose at steel mills there. China’s weaker-than-expected peak construction period and the intention of Chinese authorities to crack down on speculative pricing contributed to the spot iron ore price being soft. A number of quarterly production reports, including from Rio Tinto and Mineral Resources, also underwhelmed.

The price of lithium fell sharply in April, hurting Australia’s many lithium plays. Losses in the broader Materials sector however were offset by gains in every other sector in the ASX 300 index, chiefly Property (+5%), Tech (+4.5%) and Industrials (+4.3%). Healthcare and Financials also outperformed the broader index. Bond yields were fairly stable, both in Australia and in the US, and by the end of the month all eyes were on the Reserve Bank to see whether it would continue to pause its rate hikes. Despite expectations to continue pausing, they delivered a surprise 25bps rate hike, making this the 11th rate rise over the last 12 months.

Although the September quarter produced positive returns in Australian dollars for many markets, including Australia and the US, the underlying sentiment remained bearish as Central Banks globally continued to raise interest rates to address inflation printing at persistently high levels. Equity market returns in local currencies were much less flattering as the US dollar continued to strengthen against most other major currencies. Australian shares gained 0.5% including dividends over the quarter, although a 6.3% fall in the month of September dampened the mood as commodity prices fell and global recession fears increased. In local currency, US and European stocks both lost 5% while China and Honk Kong both fell more than 20% as Covid lockdowns weighed on economic growth, and further exacerbated with a weakening Chinese Yuan against the USD.

Although the September quarter produced positive returns in Australian dollars for many markets, including Australia and the US, the underlying sentiment remained bearish as Central Banks globally continued to raise interest rates to address inflation printing at persistently high levels. Equity market returns in local currencies were much less flattering as the US dollar continued to strengthen against most other major currencies. Australian shares gained 0.5% including dividends over the quarter, although a 6.3% fall in the month of September dampened the mood as commodity prices fell and global recession fears increased. In local currency, US and European stocks both lost 5% while China and Honk Kong both fell more than 20% as Covid lockdowns weighed on economic growth, and further exacerbated with a weakening Chinese Yuan against the USD.

Australian equities outperformed most other global markets in August, despite the backdrop of hawkish commentary from the US Federal Reserve dashing hopes that the pace of interest rate rises would slow down soon. A generally better-than-expected corporate earnings season, along with a large amount of dividends hitting investors accounts, led the S&P/ASX300 index (incl dividends) 1.2% higher last month. European shares fell 5.3% as energy supply issues continued to weigh on sentiment, while US shares dropped 4.2% as bond yields resumed their upward trend after falling the previous month. Australia’s greater composition of energy and mining companies provided a buffer of performance relative to most other markets, with investors benefitting from exposure to rising commodity prices in addition to receiving relatively high dividend yields distributed from mining and financial stocks.

August saw most companies report H2 2022 earnings which were generally better than expected, and with investor positioning bearish into the results, this led a rotation from defensives back into domestic cyclicals. The median company beat consensus by 0.7% on H2 net profits, although cuts to FY23 earnings estimates gathered pace with Materials seeing the most aggressive cuts, while Building Materials were revised lower on further input cost pressures. Conversely, insurance stocks received large upgrades with rising rates generally supportive for the sector.

US bond yields, after a retreat in July, continued their march higher as US Fed Chairman Jerome Powell delivered a short address at Jackson Hole, putting to bed any speculation that rate hikes are close to reaching their goal of lowering inflation. US 10 year yields rose 54 basis points to 3.19% while Australian 10 year yields also rose by the same margin to close at 3.60%. US 2 year yields rose 61 basis points to 3.49%, inverting the 2yr10yr part of the curve.

Concern about energy continued to weigh on European markets as it heads into Winter, and the Euro fell below parity with the $US, having depreciated by 12% this year. The Nordstream gas pipeline, which runs some 1,200 km under the Baltic Sea between Russia and Germany and provides almost half of Europe’s total gas supply, was closed by Russia for maintenance in August, adding further to anxiety there. With European gas prices having more than quadrupled so far this year, many industries have been forced to shift production offshore. Energy prices undoubtedly remain the biggest cause of an increasingly likely recession in Europe, as affordability pressures hurting both households and industry.

After 10 years of flat or falling interest rates in Australia, rising inflation finally gave way to rate hikes domestically, leading equities to their biggest quarterly loss since the Pandemic. The S&P/ASX 300 index, including dividends, fell 12.2% over the June quarter underperforming global markets. After a relatively strong start to the year, June was a month where crowded sectors like materials and financials bore the brunt of the sell-off as commodity prices fell and rate hikes fuelled concern over the housing market and consumer demand more broadly.

With the Australian Dollar falling 8% to USD0.69, this currency benefit helped offshore markets in AUD terms with Europe (-8%), the US (-9%) and Emerging Markets (-5%) all outperforming Australian shares. One of the largest swing factors in markets currently is the outlook for China, trying to navigate out of Covid lockdowns while at the same time addressing a weak housing market. Its desire to stimulate and increase money supply has put it out of sync with most other global markets entering a tightening cycle. Appearing somewhat more immune to the rate hiking seen in most other regions, there was a rotation back into China and Hong Kong. The Shanghai Composite index was up 11% in June in $A terms, although it is still -6% year to date.

On a sector level, only Energy and Utilities posted small gains over the quarter, with the defensive Healthcare and Consumer Staples also outperforming. Technology and Property stocks were the weakest sectors, with rising rates shining a spotlight on valuations. Banks were under pressure given the looming stresses in the housing market and construction industry, offsetting any benefit to net interest margins from rising rates. Weakness in Materials (-16.7%) was a large driver of broader market declines as commodities fell, finally cracking on recession fears and the outlook for weaker demand under this scenario.