It wasn’t just equities that did well as the falling bond yield lifted prices and the Global Aggregate bond index rallied 3.2%. Fading inflation and peaking interest rates, “less bad” growth in Europe and the expected acceleration of the Chinese economy fueled the market rally (total returns, local currency).
The improving inflation outlook really set the tone for markets in January given it’s a major reversal of the prevalent theme in 2022. The inflation reports for the U.S. and eurozone for December illustrated the building disinflation pressures across many sectors of the economy. Falling energy prices are largely responsible for the decline in headline rates of inflation, but good prices are also coming down rapidly. In Australia, the fourth quarter inflation figure of 7.8% year-over-year (y/y) may have been higher than expected but represents the peak in local inflation.
Falling inflation strengthened the market view that central banks will end their rate hiking cycles sooner rather than later and perhaps not push rates as high. This saw bond yields fall at the longer end of the curve helping to lift the “long duration” growthier parts of the equity market at the expense of value names.
Further adding to the positive outlook were revisions to the outlook for the eurozone which is now expected to skirt around a recession this year. The relative mild winter across the region and effective controls on gas usage reduced the fears of a deep economic impact. At the end of January, European gas storage was 75% of capacity and well above the 35% level a year ago. Further, the average price of gas in Europe is 55% lower than the average price in the second half of 2022, which helps to ease the squeeze on household spending.
Finally, the surprisingly quick end to the zero-COVID policies in China has increased the expectation for a strong recovery in the Chinese economy in the first half of 2023. This should benefit both China and its trading partners in the region and further abroad. Just like the experience in other parts of the world when mobility restrictions were lifted, there will be a sizeable lift in consumption given the still low interest rates and excess savings built in the past two years.
The heavy falls in stock and bonds in 2022 have created a very attractive long-term entry point for investors. But January’s gains show just how fast markets can re-price for better news and plenty of risks remain. Still, 2023 is so far one that is looking “less bad” for the economy and “better” for markets.
Economy:
- The fourth quarter of 2022 was the peak in Australian inflation, but the figure was higher than expected. Consumer price index inflation rose to 7.8% y/y, the highest since 1990. Price pressures were fairly broad across housing, energy and holiday and travel. Even with higher inflation, the figure was below the Reserve Bank of Australia’s expectation and the disinflation pressures have increased since.
- The labour market data for December was a little softer than expected but the unemployment rate was unchanged at 3.5% (accounting for prior month revisions). Employment fell by 14,600 jobs. While the unemployment rate is expected to rise in the coming months, a collapse in the labour market is unlikely. Vacancy data has fallen off its peak but is still elevated by historical levels.
- The retail sales picture has been mixed for the past two months. November’s data was strong at 1.4% month-over-month (m/m) (12.5% y/y) with prior months data lifted higher. However, consumers just brought forward much of their Christmas spending to earlier in the year as sales figures collapsed by 3.9% m/m for December. While it is likely that retail sales were lower in December, the data may have been distorted by the adjustment process given the very large decline compared to expectations.
- House prices continue to fall in January and the capital city dwellings price index fell by 1.1% or down 8.9% since the peak in April 2022.
- Building approval rose 18.5% in December driven by apartments. The data has been volatile given the backlog of approvals needing to be cleared from the pandemic, rather the suggesting a looming increase in construction activity. This is corroborated by the move lower in housing loan commitments (-4.3% m/m). This is the eleventh consecutive fall in loan commitments as the impact of falling house prices and higher rates weighs on borrowing activity.
Equities:
- After a weak close to 2022, investors welcomed the strong gains in January. The ASX 200 was a marginal underperformer in local currency terms with a 6.2% gain, compared to the 6.3% for the S&P 500. Emerging markets bested the developed world has positive sentiment towards China lifted Asian region equity markets.
- At the sector level, consumer discretionary stocks (9.9%) were the best performers, followed by materials (8.9%) and REITs (8.1%). At the other end of the spectrum were utilities (-3.0%), energy (+1.3%) and health care (3.9%).
- The gains in equities this year have been driven by a valuation re-rating. While valuations across equities are not expensive by historical standards, they have crept higher since the start of the year offsetting some of the weakness in the earnings outlook.
- The view of stabilizing economic activity outside of the U.S. is helping to slow the downgrade cycle. Earnings revisions for the U.S. have become less negative. Investors are buying into the soft-landing scenario and discounting the potential hit to corporate earnings should a recession materialize.
- By the end of January, the S&P 500 fourth quarter earnings season was nearing its half-way point. Based on a combination of reported earnings and earnings expectations, the U.S. market was on track to record a 9.6% decline y/y based on operating earnings. Earnings surprise was running at -1% and the share of companies beating earnings estimates (63%) was well below the historical average.
Fixed income:
- Stabilising global growth and easing inflation pressures were reflected in falling bond yields. The Australian 10-year yield fell by 50bps to 3.55%, while the U.S. 10-year Treasury yield dropped 35bps to 3.88%.
Other assets:
- It was a mixed bag for commodity prices. The price of Brent oil was marginally down to USD 84 a barrel. The movement in the USD and re-opening effect from China are causing cross-currents for the oil market.
- Expected Chinese demand helped to support the iron ore price which rose to USD 129 a ton. Gold price rose strongly to USD 1,924 mostly a reaction to safe haven flows.
- The market view that the U.S. Federal Reserve was nearing the end of its rate hike cycle combined with renewed interest in investments outside of the U.S. challenge the U.S. dollar over the month. The Australian dollar was up 3.55% against the greenback, while the British pound gained 1.96% and Canadian dollar 1.86%.
