Perpetual Wholesale Balanced Growth Fund (PER0063AU) Report & Performance

Global financial markets consolidated in July following a strong first half for risk assets.

– US equities (+3.2%) rallied, outperforming the broader developed market (+2.9%). Performance during July was more broad based than recent months in contrast to the strong year-to-date returns which have been concentrated in a narrow group of large cap tech stocks. Indeed, traditional cyclical sectors including financials (+4.8%) and materials (+3.9%) outperformed most tech related sectors such as IT (+2.6%) and consumer discretionary (+2.3%).

– Meanwhile, Australian equities (+2.9%) were supported by the RBA’s decision to keep rates on hold as well as the rally in traditional value sectors such as financials, materials, and energy.

– Elsewhere, Emerging markets (+6.1%) performed strongly, led by China (+10.1%) which recovered its 2nd quarter losses, supported by regulatory easing and expectations of increased stimulus.

– In fixed interest markets, the US 10-year yields (+14bps) rose further as the US Federal Reserve (The Fed) raised rates another 25bps to 5.25%-5.5%, whereas Australian 10-yr yields rose marginally while the short end of the curve rallied as the RBA left the cash rate (4.1%) unchanged for a second meeting of the past four, which suggested that official Australian interest rates are close to peaking.

– In credit markets, both USD and EUR denominated credit rallied, as economic data which detailed resilient economic growth and falling inflation provided some optimism to investors that the odds of a US soft landing from 16 months of aggressive rate hikes were higher than previously thought.

Global equity markets rallied over the quarter in response to stronger-than-expected March quarter growth in China and Europe, the Fed’s large-scale backstop for the US regional banks and the potential widespread benefit from artificial intelligence over time, all of which provided a solid foundation for the near-term macro backdrop. While this facilitated modest earnings upgrades in key markets including the US and Japan, the Q2’23 rise in regional sharemarkets was underpinned by rising valuations, defying a strong quarterly rise in real 10-yr bond yields as measures of the equity risk premia were pulled down to levels not seen since the aftermath of the tech boom.

– Japanese equities (+18.54%) surged on the back of a potent mix of reopening dynamics, a surge of inbound tourism, strong nominal income growth, a renewed focus on listed equity return on equity, and strengthening signs that the economy has finally resolved 30 years of chronic deflation. This combination of factors sparked a modest increase from foreign investor interest in the Japanese market given its attractive valuation, but most investors remain cautious having seen multiple false recovery signals for over 20 years.

– US equities (+8.74%) continued to rally strongly, dominated by the strong performance of a handful of large cap technology stocks which underpinned double-digit price growth in IT (+17.2%), consumer discretionary (+14.6%) and Communication services (+13.1%) which were more than double the returns in all other sectors.

– European equities (+4.3%) advanced as their recent recession was far milder than expected several months ago, but UK equities (-0.3%) declined as the Bank of England accelerated the pace of monetary tightening in response to a surge in wages growth and core inflation.

– Australian equities (+1.0%) continued to lag the performance of global equities given the local market’s defensive composition and heightened sensitivity to rising bond yields and falling commodity prices.

– Chinese equities (-8.9%) retreated from their Mar-23 quarter bounce as signs emerged that the reopening boom was lacking momentum amid signs of moribund activity in the construction sector, inflation approaches deflation territory, and its credit impulse turned negative.

Financial markets were mixed in May following a robust start to the year across almost all asset classes (with the notable exception of commodities). This strong first half has been despite headwinds including moderating earnings growth, tightening monetary policy, a potential US treasury default, turmoil in US regional and global banks and concern over a looming credit withdrawal. While US equity performance has been wholly reliant on the positive contribution of high growth tech stocks, more traditional value markets such as Europe, the UK and Japan have also performed well.

– During May, US equities (+0.4%) ticked marginally higher, however this masked a widening gap between the performance of value stocks and sectors (-3.9%) and growth (+4.6%) led by the strong performance of the tech giants.

– Japanese equities (7.0%) were buoyed by attractive valuations, the depreciating Yen and the return of inflation after years of deflationary conditions. Meanwhile, Chinese equities (-8.2%) continued to recede from their post reopening peak as economic growth indicators weakened.

– European equities trailed the broader developed market with French stocks (-3.9%) falling sharply. The value correlated UK market (-4.9%) underperformed, reflecting the broader relative outperformance of growth stocks.

– Australian equities (-2.5%) underperformed developed markets on the back of hawkish monetary policy expectations and weakened materials demand.

– Domestic bond yields sold off over the month with 10-year yields rising 26bps to 3.6%. US (+19bps) ten-year yields also rose during the month while the short end saw elevated volatility as the fight over increasing the debt ceiling continued until the end of the month.

We continue to observe a disconnect between the strength of the US equity index returns and weakening economic indicators and corporate profits. The US equity market continues to be led by the large cap tech giants which have benefitted from moderating long term bond yields over the first half of 2023 and robust earnings results. US equities outside of the largest market cap stocks have starkly underperformed, suggesting that the market is pricing in weakening corporate profits, but this is being masked by rising valuations of a select few firms.

There was a reversal of fortunes in equity and bond markets in February as a series of strong economic data saw a repricing of monetary policy expectations.

– US equities (-2.4%) gave back a portion of their 2023 gains mainly due to a sharp repricing of the US Federal Reserve’s (the Fed’s) rate expectations.

US equities weighed on the broader developed market index with the MSCI World (-1.5%) also falling in February.

– European Equities (+1.9%) – led by France (+2.6%) and Germany (+1.6%) – were more resilient, supported by the improving economic outlook for the region.

– Australian equities (-2.5%) were lower following a strong start to the year as rising bond yields and interest rate expectations weighted on stock valuations.

– Chinese equities (-9.9%) gave up almost all of their year-to-date gains as US-China tensions escalated and the US Dollar rallied.

– US bond yields moved higher over the month and the yield curve inversion intensified to a 4-decade high as 2-year yields spiked. Australian yields also rose, and the curve flattened as short end yields moved sharply higher.

Markets surged in January as investors responded to moderating inflation while fears of a severe synchronised global recession diminished. US inflation continued to ease while resilient activity and falling energy costs in Europe alongside Chinese reopening contributed to the buoyancy in financial markets.

– European equities (9.9%) again led developed markets on the back of strong gains in Germany (8.7%) and France (9.6%). Falling energy prices, targeted stimulus and resilient demand have all contributed to a greatly improved outlook for the region.
– US equities (6.3%) rose as investors reacted to better-than-expected CPI and growth indicators. Lowered discount rates (as a result of falling bond yields) saw growth stocks (8.3%) outperform value (5.2%).
– Australian equities (6.2%) had their best January performance on record, despite marginally trailing the broader developed market (6.5%). Moderating inflation saw bond yields fall sharply, with 10-year yields (-50bps) rallying strongly over the month.
– Chinese equities (11.8%) continue to outperform developed markets as reopening, monetary stimulus and easing regulations fuel rising growth expectations.
– Bond yields fell globally in reaction to improving inflation print with rallies in 10-year US (-35bps), UK (-31bps) and German (-22bps) bonds. The January rally was substantially attributable to the unwinding of some of the elevated recession fears in the US and globally. The economic data were generally better than expected (more resilient growth and lower inflation).

In particular:
• The US is still on the narrow path to a soft landing.
• Europe has averted a severe recession that was widely expected just six months ago, owing to a warmer winter and a rapid recalibration of energy supplies.
• Growth prospects in China have been revised up following the reopening from COVID and policy relaxation.

Australia’s path to a soft landing remains more viable than the US. The RBA slowed the pace of interest rate hikes during the December quarter and minutes from the final meeting of the year revealed that the possibility of no increase was discussed for the first time this cycle. The RBA has a more potent mechanism to address household spending given highly leveraged household balance sheets and a large amount of mortgages being at variable rates which are highly sensitive to changes in the RBA’s overnight cash rate.

At the same time, the economy looks quite solid at present and stands to benefit from Chinese reopening and improved relations between Canberra and Beijing. The outlook for China has improved materially on the back of a combination of easing COVID restrictions, relaxed collateral and equity issuance standards in the property sector and stimulatory monetary policy. The abandonment of the zero-COVID policy is expected to be very supportive for economic activity following an initial surge in cases. The government also issued a series of measures intended to support the property sector which has languished since 2020, including credit support for highly leveraged housing developers, financing to ensure completion and transfer of projects, and loan assistance for home buyers. The key contributing factor to relative performance over the quarter was the Fund’s global equity stock selection. Value sectors and stocks substantially outperformed growth and the Fund’s global equity exposure was rewarded. Partially offsetting this however was the negative contribution of the Fund’s US and European put options.

At quarter end, the Fund was underweight across global and Australian equities. All equity exposures retain their long-standing quality and value bias which are expected to continue to outperform against a backdrop of rising interest rates and slowing earnings growth. During the quarter, the Fund’s US duration was increased while remaining underweight and short of benchmark duration. The Fund’s exposure to US and Australian government bonds remains partially offset by a small, short (negative) position in Japanese bonds. This position performed well over the quarter as the Bank of Japan elected to relax its yield curve control measures, precipitating a selloff in long term yields.