Market update – quarter ending 31 December 2023

Market summary:

Global equity markets¹ rebounded from the previous quarter and returned 9.8% over the December quarter. On a regional basis, among the major global equity markets, US equities (S&P 500²) returned 11.7% (USD terms) and outperformed the rest of the world, followed by European equities³ which returned 8.6% (Euro terms) while UK equities⁴ and Japanese equities⁵ lagged but generated positive returns with +2.3% (GBP terms) and 2% (JPY terms) respectively. Emerging markets⁶ returned 7.9% (USD terms) with Indian equities outperforming with 9.6% (USD terms) while Chinese equities underperformed with -4.2% (USD terms). Australian equities returned 8.3% (AUD terms) and comfortably outperformed New Zealand equities which returned 4.2% (NZD terms).

At a sector level, Real Estate (+17.2%), Information Technology (+16.9%), Industrials (+11.4%), and Financials (+11.2%) were the top performing sectors. Energy (-5.5%) was the worst performing sector, followed by laggards such as Consumer staples (+3.2%) and Healthcare (+4.2%). From a style perspective, Global Defensive⁷ (+9.4%) underperformed Global Cyclical⁸ (+11.2%) companies; while Growth⁹ (+11.9%) comfortably outperformed Value¹⁰ (+6.8%) companies.

A sharply downward trajectory in bond yields over the quarter resulted in strong returns for bonds. Global bond returns¹¹ (+5.95%) were in line with domestic bond returns¹² (+6.0%). For global bonds, corporate bonds (+7.1%) outperformed government bonds (+5.2%), whereas for domestic bonds, corporate bonds (+4.6%) underperformed government bonds (+6.7%).

The oil price (WTI crude oil priced in US dollars/barrel) fell over 21% to USD71.7 while gold surged +11.6% (USD terms). The NZ dollar rose 5.4% vs the US dollar resulting in NZD hedged returns outperforming unhedged returns.

Context:

The December quarter saw strong returns across most major asset classes. A key theme for the quarter was a meaningful easing of financial conditions¹³, especially in November and December as markets formed a view that central banks, starting with the US Federal Reserve, would begin cutting interest rates in 2024.

Rising equity markets, falling US treasury yields, sliding oil-prices, and a weaker US dollar caused the Goldman Sachs US financial conditions index to fall by nearly a percentage point in November. This was the largest easing in US financial conditions of any single month in the past four decades. The key factors behind these developments were:

(1)   US Federal Reserve (Fed) officials began acknowledging in October that the tightening of financial conditions in recent months had likely dampened the need for further interest rate hikes and in late November a Fed official remarked that if inflation continued to fall over the next several months, it could lead to interest-rate cuts.

(2)   A widely watched inflation measure for November registered 1.9% on a six-month annualised basis, marking the first time in more than three years that this measure was below the Fed's inflation target. Given headline inflation rates have been declining in most major advanced economies over the past 12 months, the disinflation theme gained traction as a key macro-economic theme.

(3)   the US Treasury published its quarterly debt-issuance plan in November which was slightly less than what most market participants had expected and suggested a slower pace of increases of issuance with longer maturity dates. This helped lower bond yields further.

At its December monetary policy meeting, the Fed surprised markets with a notable shift in its monetary policy approach by projecting a lower interest rate path (by 75bp) in 2024. At the press conference, Fed Chair J Powell conceded that the Fed has already started discussing the topic of dialling back the amount of policy restraint in place. Markets immediately began to price rate cuts amounting to ~160bp by the end of 2024 with the first rate cut by March 2024.

The in turn led to a positive feedback loop for equity markets, and was additionally supported by the release of US economic data indicating consumer resilience, better than expected third quarter earnings releases and stable consensus analyst earnings expectations for 2024.  There was also a tailwind from a combination of the reversal of the very depressed positioning and sentiment levels seen in late October, along with seasonality factors and increased share buyback activity. US equities saw nine straight weeks of inflows through the middle of December, the longest streak in two years.

Despite the magnitude of the December quarter rally, there remain areas of concern to be mindful of. These include: (1) the market’s tendency to prematurely predict central bank policy shifts towards a more accommodative monetary setting; (2) the lagged effects of the tightening cycle on the economy; (3) a drag on corporate pricing power, revenue growth from potential disinflation; (4) overbought conditions, (5) a weaker outlook in China (due to structural problems in its housing market and high youth unemployment) and Europe (due to low company earnings growth amid uncertainties in the recovery).  

The quarter also saw a significant geopolitical event unfolding as tensions increased in the Middle East between Israel and Hamas, as well as disruption in maritime trade through the Suez Canal leading to a more complex and challenging landscape for global commodity trade.

In New Zealand, net migration experienced a record 129k inflow for the October 2023 year; still core inflation measures indicated underlying inflation pressures are weakening, although inflation at 5.6% is well beyond the Reserve Bank of New Zealand (RBNZ)’s target range. The RBNZ left the cash rate at 5.5% during the quarter, unchanged since it last raised rates in May, but surprised markets by releasing economic forecasts that indicated further tightening could be required. The RBNZ expects the recent strength in migration to add upside risks to inflation. On the other hand, third quarter GDP missed expectations and showed that New Zealand’s economy had contracted by 0.3% while the employment data conveyed that the tight labour market is starting to abate, and private sector wage inflation is likely to weaken ahead.

¹ MSCI World Net Index (local currencies)

² S&P 500 Total Return Index (USD)

³ Euro Stoxx 50 Total Return Index (EUR)

⁴ FTSE 100 Total Return Index (GBP)

⁵ Topix Total Return Index (JPY)

⁶ MSCI Emerging Markets NTR Index (USD)

⁷ GS World Defensive sectors (local currency)

⁸ GS World Cyclical sectors (local currency)

⁹ MSCI World index growth (local currency)

¹⁰ MSCI World Index Value (local currency)

¹¹ Bloomberg Barclays Custom Composite Index (100% hedged to the NZD)

¹² Bloomberg NZ Bond Composite Index 0+ years

¹³ Changes in asset prices and interest rates which can also potentially affect the future growth of the economy.

_{Source: BT Funds Management}