KEY POINTS
- Global equity markets responded positively to the clear-cut U.S. election result.
- However, concerns that US cash rates will not fall by as much as previously expected caused bond yields to rise and US equity valuations to decline towards the end of the quarter.
- Further weakness in the $A resulted in currency related gains for Australian investors with unhedged global exposures.
POST ELECTION EQUITY RALLY PROVES SHORT-LIVED
Global equities rallied strongly mid-quarter following the Republican victory in the U.S. Presidential election. The clear-cut election result was viewed positively as it removed a source of uncertainty and set-up a reduction in US corporate tax rates and deregulation initiatives. However, some of November’s gains were reversed in December. The main catalyst for the change in share market direction appeared to be a shift in the outlook for interest rates, with fewer U.S. cash rate reductions now expected. Within U.S. equities, it was once again the large technology stocks that outperformed, with the sector gaining 5.7% for the quarter – well ahead of the broader S&P 500 Index increase of 2.4%. Tesla was particularly well supported following the U.S. election result, with the stock posting a quarterly share price increase of 54.4%. Smaller companies also rallied strongly following the election but were heavily impacted by the change in interest rate outlook, with the U.S. Russell 2000 Index finishing flat for the quarter. Outside of the US, the concern over higher interest rates was less significant and share market performance was mixed. Germany (up 3.0%) and Japan (up 5.3%) generated gains. Japan’s performance was positively impacted by an announcement indicating the Japanese Government Pension Investment Fund was increasing its return target, which could result in a higher allocation to Japanese equities.
The decisive election result had a negative impact on emerging markets. The prospect of increased tariffs and a strengthening in the $US, weighed heavily on emerging market sentiment, with the MSCI Emerging Market Index dropping in value by 4.6%. The Chinese market pulled back from the strong gains recorded in the month of September, when an economic stimulus program was announced. Tariff expectations also impacted on commodity markets, with further weakness in the iron ore price being detrimental to the Brazilian market, which declined 10.1% over the quarter.
Higher bond yields had a significant impact on listed property. With yields becoming less attractive on a relative basis as bond yields increased, global listed property declined by 7.5% and Australian listed property was 6.1% lower. Infrastructure, however, was better supported, posting a gain of 1.0% for the quarter.
RESOURCE STOCKS WEIGH HEAVILY ON LOCAL MARKET
Australian equities underperformed over the December quarter, with the S&P ASX 200 Index falling 0.8%. Resource stocks continued to lose ground, with falling iron ore prices weighing on the large mining companies. Weakness continued in the energy sector as oil prices remained at low levels despite the ongoing conflict in the Middle East. Energy stocks fell 5.4% over the quarter. Resource and energy stocks have now declined by 14.9% and 13.9% respectively over the past year. Also heavily detracting from returns last quarter were consumer staple stocks. A weaker than expected trading update from Woolworths (down 8.4%) was the main contributor the sector’s decline.
In contrast, the financial sector made a strong positive contribution to the asset class last quarter. Banks continued to be well supported, despite lofty valuations. There was also strong growth in the price of insurance stocks, with earnings being supported by higher premiums.
CASH RATES LOWER BUT BOND YIELDS HIGHER
Cash rates continued to decline with monetary policy easing around the globe last quarter. The U.S. Federal Reserve reduced its cash rate by 0.25% in each of November and December, with the rate now operating in a range between 4.25% and 4.5%. However, a more “hawkish” tone from the Federal Reserve Chairman in December pushed back expectations of further rate reductions, with ongoing buoyant economic conditions making lower inflation and further rate reductions less likely. Longer term bond yields increased as a result, with the U.S. 10-year Treasury Bond yield increasing from 3.81% to 4.58% over the quarter. Australian yields, however, were somewhat more stable, with ongoing weakness in the local economy still providing an opportunity for a lowering of the cash rate in early 2025. None-the-less, Australia’s 10-year Government bond yield still increased 0.41% over the quarter to finish at 4.37%.
The election result and a higher interest rate outlook in the United States provided a source of support for the $US last quarter. As a result, the $A declined from U.S. 69.3 cents to U.S. 62.2 cents. The $A also declined against the Euro and Japanese Yen, by 3.8% and 1.1% respectively. With commodity prices remaining relatively soft and local interest rates expected to fall, there has been a decline in support for the $A over recent months. However, for investors with unhedged currency exposure attached to overseas investments, this has been a source of significant gain over the past quarter.
CONSIDERATIONS FOR INVESTORS
For much of 2024, financial markets across the globe were highly synchronised, with patterns in U.S. equity and bond markets being mimicked across other geographical markets. Trends in the month of December, however, were notably more disparate. Equities declined in the United States but increased in Japan and parts of Europe. Bond yields were steady in Australia, but sharply higher in the U.S. Within equity markets, investors retreated to defensive stocks in Australia, but continued to support most of the large technology stocks in the U.S.
Overall, there appeared to be a strong element of logic in the divergent movements across equity and bond markets in December. Potentially, the month is the commencement of a period where investors become more discerning over asset selection, with fundamentals playing a greater role than momentum and sentiment in determining performance. Perhaps, valuations have reached a level whereby the marginal investor is no longer willing to just “buy the market” and needs supportive fundamentals to justify further investment.
In fact, there is some evidence to suggest that the dominant market leadership provided by the U.S. technology sector over recent years has been waning in influence. In the year to June 2024, the correlation of monthly returns between the technology-heavy U.S. NASDAQ Index (in local USD) and the Australian S&P ASX 200 Index was relatively high at 56%. By the end of 2024, this 12-month rolling correlation had dropped to just 5%.
Should directional performance across different geographical regions and sectors of equity markets continue to become less correlated, then opportunities for asset allocation strategies to add value may be enhanced. Recent years have seen markets heavily impacted by the Artificial Intelligence (AI) thematic and the price movement of the large U.S. technology stocks. While these trends have dominated, it’s essential to recognise the importance of diversified asset allocation in managing risk and capitalising on investment opportunities.
The last two calendar years on global equity markets have been abnormal in terms of the magnitude of return, with both 2023 and 2024 delivering returns in excess of 20%. Whilst a continuation of this level of return is unlikely, there remains cause for optimism given the favourable global economic backdrop, strong position of corporate balance sheets and the potential for AI to deliver yet to be recognised opportunities. However, not all companies, sectors or geographies are well positioned to capitalise on these opportunities. Much of the Australian share market, for example, appears challenged to deliver the earnings growth assumed in current valuations – although Australian resource stocks are appearing increasingly undervalued compared with the broader asset class.
As we look ahead to 2025, it is crucial to acknowledge that it is impossible to predict what the future will hold for investment markets around the world. Therefore, maintaining a well-diversified portfolio and being prepared to adapt to changing market conditions will be key strategies for investors. By focusing on asset allocation and remaining vigilant about market shifts, investors can better navigate the uncertainties and optimise the potential of achieving their financial goals.
Important Information
The following indexes are used to report asset class performance: ASX S&P 200 Index, MSCI World Index ex Australia net AUD TR (composite of 50% hedged and 50% unhedged), FTSE EPRA/NAREIT Developed REITs Index Net TRI AUD Hedged, Bloomberg AusBond Composite 0 Yr Index, Barclays Global Aggregate ($A Hedged), Bloomberg AusBond Bank Bill Index, S&P ASX 300 A-REIT (Sector) TR Index AUD, S&P Global Infrastructure NR Index (AUD Hedged).
