MARKET SUMMARY

• International equities rallied, but the Australian shares fell – After a pullback in April, equity markets rallied strongly in May and June driven by the US tech majors. In local currency terms, the ASX200 (-1.1%) underperformed the US S&P500 (+3.9%), the MSCI World ex Australia Index (+2.2%) and the MSCI Asia Pacific ex Japan Index (+5.5%). In $A terms, however, the MSCI World ex-Australia Index only rose 0.3%. Australian property securities (AREITs) fell 6% due to higher bond yields.

• Bonds sold off – The Bloomberg AusBond Composite 0+Y index fell 0.84%. Australian 10-Year bond yields rose 35bps to 4.31%, while US 10-Year bond yields rose by 20bps to 4.40%. Credit spreads are relatively tight in the US but remain wider in Australia.

• Australian Economy – The RBA held cash rates at 4.35%. The labour market remains tight but is slowing, but inflation data was stickier than expected raising concerns that the RBA may entertain near-term 25bps rate hike. Retail sales, consumer confidence and building activity remained soft. However, house prices continued to rise, and the government has initiated income tax cuts and cost-of-living relief to support households. The $A/$US rose 2.3% to 66.7c.
• Global economic activity – The US Federal Reserve kept rates steady at 5.25-5.5% as inflation was better behaved. The labor market is slowing but remained resilient. However, housing market activity and consumer activity is softening. The Bank of Canada and European Central Bank cut rates given low inflation and high unemployment. The subdued real estate market continues to plague the Chinese economy.
• Commodities – Natural gas prices soared 47%, while Base Metals (+9.3%), Precious Metals (+6.5%) and iron ore (+3.8%) also rallied. Oil (-2.3%) and soft commodities fell.

AFLPA PRA PORTFOLIO PERFORMANCE - AS AT 30 JUNE 2024

The investment objective of the AFLPA PRA is to maximise the net (after fees and taxes) earnings of the funds at the acceptable level of risk, having particular regard to protecting the long-term capital value of the investments. The assets of the AFLPA are managed as 4 individual sub funds with each of the sub funds having their own individual investment objectives and associated investment strategy.

For more information on the investment strategies, please see the AFLPA PRA Handbook.

OUTLOOK

FY24 delivered strong investment returns due to falling inflation, expectations of central bank rate cuts, more resilient than expected economic conditions (led by the US but also in Australia) and technology sector earnings upgrades fuelled by substantial investment in Artificial intelligence.

In the US and Australia, the stronger than expected headline growth levels, employment markets and wage outcomes have stemmed the disinflation trends seen late last year and led to a re-appraisal of the timing and magnitude of rate cut expectations. This has seen our view of a ‘higher for longer’ rate environment accepted by the market. Despite this, equity markets have remained resilient as investors still expect solid earnings growth in FY25 driven by growing IT sector revenues and future interest rate and tax cuts which will support consumption.

We have felt that economic growth would weaken in many developed markets into the back half of the year as the cumulative impact of higher interest rates and cost of living pressures crimp consumer spending. There are increasing signs of that weakness being felt in retail sales, housing activity, business insolvencies and some labour market indicators. Migration rates are also now slowing. Our short-term concern is that this weaker scenario is not priced into the current “soft landing” view of the market.

The broader view is that as inflation retraces central banks will cut rates supporting global economic growth in 2025. However, rate cuts may be modest, Australia is set to lag and divergence in growth may occur. While European and Asian growth is expected to improve, the US economy (which has been the engine room for growth) is forecast to continue to slow over the next six months. Chinese growth remains on track for ~5% growth as stimulus is enacted and renewable energy investments rise, but there is still a lack of conviction over some policy initiatives to support growth in the property market.

We would also argue that the market is not pricing a further rise in geopolitical tension. One cannot dismiss the geopolitical risks that not only remain, but may escalate further, especially with protectionist measures likely to be initiated against the Chinese by some major western economies. Higher tariffs, onshoring and Trump policies could all conspire to lessen the disinflation progress seen over the last year. A potential implication of this could be higher inflation and greater US government debt. Political changes in France look likely to lead to a hung parliament potentially limiting progress in Europe.

While we remain positive on the long-term strategic merits of equities, our tactical assessment remains that market conditions will get increasingly difficult over the remainder of 2024. Central Banks in the US and Australia will need to see evidence of lower inflation, which may require a growth slowdown, before offering a more dovish view. Meanwhile in the US, major technology companies will have to keep delivering on (and potentially above) already increased market expectations for earnings growth. Given the narrowness of the market rally in the US and globally, we are wary that any disappointment could lead to increased volatility of returns. Our asset allocation positioning therefore carries a slight defensive tilt to preserve capital by being slightly underweight equities and carrying a modest overweight position in cash.

From an income perspective, dividends from Australian equities are forecast to be flat to slightly up in FY25 on FY24. The current income yield on Australian equities is ~3.8% (and ~5.1% grossing up for franking credits). Income from Fixed income and cash is robust at current levels of ~4.5%.

Importantly, both defensive and growth asset classes are positioned to deliver reasonable returns over the medium term. A scenario of falling inflation, rate cuts and economic resilience is supportive for investment returns. Should economic activity weaken considerably, central banks are better positioned to cut quickly. Key risks to this include higher and stickier inflation and increasing geo-political turmoil.

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