Weekly Market Update - 13/07/2021

The week that was

The market was a little more volatile last week in that we saw declines throughout most of the week, amounting to 4% in Japan (the worst performer) at its lowest. Then near the end of the week the winds changed and markets recovered strongly leaving global markets up slightly for the week and Australia level.

There are currently many, many economic cross currents and increasingly little consensus amongst investors but one thing most agree on is that bond markets are proving both influential and confusing. Long term rate expectations moved down to levels last seen in February and stocks sold-off suggesting that the market was looking through current price spikes and seeing an economic slowdown ahead, perhaps due to the COVID delta variant and a waning reflation impetus. This is plausible although not particularly supported by ever tighter credit spreads (junk bonds in the US now yield less than current inflation and investment grade bonds only a little more than levels of inflation expected when things subside to 'normal').Then the economic mood brightened late in the week with rates heading higher, equity markets rebounding and value stocks catching up again. This was possibly related to a very positive new jobs report published in Canada and/or the announcement of more supportive of monetary policy by People’s Bank of China, both on Friday.

If all this seems esoteric and still more than a bit US-centric it is a reality of life that even a much anticipated RBA press conference outlining a (sort-of) tapering of government bond purchases had only a momentary impact on local bond prices. Local 10-year bond rates rose by almost 0.1% on Tuesday afternoon after the press conference but by the next morning the gravitational pull of the US market had reasserted itself and they were back within 0.02% of US counterparts. That means that it is also a fact of life that rates are low and?house prices are moving ever higher in Australia because real rates of interest in the US are so low.???

One could also argue that the other bit of big corporate news in Australia is not unrelated to the US Fed’s monetary stance. Industry Funds Management, a local industry fund backed manager of predominately unlisted assets, has put in a bid for Sydney Airports for $22bn. If it goes ahead it will be the biggest corporate takeover in Australia’s history. The price puts it back to pre-Covid levels despite having issued equity equivalent to 15% of it’s market cap and having lost at least 2 years worth of earnings. This only makes sense if interest rates are to remain lower than they were 18 months ago. Only time will tell whether that proves to be fruitful investment for industry fund members but in the here and now it resulted in a 33% uplift for current shareholders and squeaked the market in positive territory for the week. Most other sectors remained in the red with the worst returns coming from consumer discretionary stocks like Wesfarmers, Tabcorp and Aristocrat, with the Sydney moving from lock down lite to something altogether more restrictive.?However, it was modest falls returns from the banks, (given their size in the index) that had the biggest impact. Interestingly, one of the main positive contributors was Woodside Energy which, along with the global oil majors, has not been able to benefit from the rise in oil prices this year.??The big local miners and consumer staples also made modest gains.

Asian and many emerging markets also lagged again last week, following patterns that have dominated this year. The delta COVID variant has cast doubt on an Asian led recovery but Chinese regulatory overhang has had an even bigger impact on returns given how important the big Chinese tech companies have become in both the Emerging Market and World Indices.

Gold was the best performer last week, up 2%, while most other commodities were down slightly for the week.?

?

What we'll be watching this week

There have been many explanations for the recent falls in bond rates, many focusing on range of so-called technical factors - excess demand for Treasuries by various institutions including banks, insurance companies and hedge funds. At any rate there are a proliferating number of theories for the current paradox of lower rates even as actual inflation heads higher but even more confusingly bond market implied rates of inflation say one year from now?(the difference between yields on fixed income Treasuries and their Inflation Protected equivalents) have also drifted down in the last few weeks. At some point in the next year, and probably, the next 3-6 months, this unbalanced equation will have to resolve itself (either inflation will subside or rates will rise).?We heard perhaps the most convoluted explanation for the behaviour of the bond market a couple of weeks ago - long-term bond yields are falling because rising inflation will force the Fed to raise rates, which will cause a recession and then rates will have to fall even more. This version of future events has since gained credibility, so who knows but this weeks US CPI release might prove to be another piece in the puzzle.???????

We have noticed that many active managers have been drawn to the relative value offered by large Chinese tech companies (like Tencent and and Ali Baba) and in our June monthly reports published last week, it emerges as one of the primary drivers of relative performance in many portfolios over the last three months. We have just discussed the posture of the Chinese government with emerging market manager Trinetra and we are hoping that the pointed way in which China poured cold water on the IPO of ride-hailing company Didi Chuxing last week will mark the low water mark for this trend. Or at least that the stocks affected have become cheap enough that they prove more resilient.

While we will have to wait until the end of July to get an insight into the latest earnings for US tech stocks, the US earnings season starts in earnest this week and many of the large banks are first up. This is being seen as another important milestone as in the last two quarterly reporting periods companies beat already high expectations. Now expectations are even higher and, with markets also already at all time highs, weaker numbers (which must be expected at some point) could undermine market values quite substantially.

---------------------------------------------------------------------------------------------------------------

Integro Holdings (WA) Pty Ltd

ABN 61 612 297 739 AFS License No. 489444

General advice warning

The information, including tax information and any advice provided in this document has been prepared without taking into account your objectives, financial situation or needs. Because of that, you should, before acting on the advice, consider the appropriateness of the advice, having regard to those things. [If the advice relates to a particular financial product: You should obtain the relevant Product Disclosure Statement for any product mentioned and consider its contents before making any decision.]