MARKET SUMMARY
Share markets rose – In local currency, the ASX200 (+4.6%) outperformed the MSCI World ex Australia Index (+3.9%) and US S&P500 (+2.7%). European markets rallied strongly while Asian markets relatively underperformed. In $A terms, global equities rose 2.7%.
DeepSeek rattled the US IT sector – Not long after President Trump announced the new $500bn “Stargate” project to build essential data centres and AI computing infrastructure, a Chinese start-up ‘DeepSeek’ (a competitive AI model to the likes of ChatGPT) announced that it could be produced at a fraction of the price. Hardware and chip producers suffered. NVIDIA fell 10.6% over the month. Investors are debating whether the hundreds of billions being spent by large hyperscalers are going to produce an economic return or whether low-cost production will accelerate and widen investment in AI. Hyperscalers such as Meta have since reaffirmed their capex plans, but the moats of some of these companies are starting to be questioned. IT is a large sector in the US equity market and has been a key driver of gains for US and global equities over the last 2 years, so the implications may be meaningful.
ASX cyclicals outperformed – Cyclicals / rate sensitive sectors rallied as markets priced in a February rate cut by the RBA. The best performing sectors in the ASX200 were Consumer Discretionary (+7.1%), Financials ex property (+6.1%) and Property / AREITs (+4.7%). Gold stocks also performed very well. Conversely, the worst performers were defensive sectors such as Utilities (-2.4%), Consumer Staples (-0.7%) and Communication Services (-2.4%). Taking market capitalisation into account the key contributors to ASX gains were the major banks and Wesfarmers. Globally, Communications and Healthcare performed best while IT lagged.
Bonds treaded water – Australian bonds (Bloomberg AusBond Comp 0+Y index) gained 0.19%. Australian 10-year bond yields rose 7bps to 4.43%, while US 10-year bond yields edged back 3bps to 4.54%. Yield curves steepened. Credit (ex MBS) markets gained 0.44%. While spreads have tightened, Credit market fundamentals remain sound.
Global Economy: The Fed paused – The US Federal Reserve kept rates unchanged at 4.25-4.5% wanting to see further progress on inflation. Robust economic data, sticky inflation, a strong labor market, solid consumer demand and Trump tariffs have seen inflation expectations lift. At the end of the month the market was pricing in less than two rate cuts in the US this year. The European Central Bank (ECB) cut rates 25bp to 2.75%. Investors expect rates to fall below 2% by year-end given weakening demand in Europe. In China, Q4 GDP figures released were stronger than expected at 5.4% (year-on-year), however banks loans and housing related data remained soft. The market remains sceptical and awaits detail on domestic stimulus. The Bank of Japan raised rates 0.25% to 0.5%.
Increased uncertainty under the new US administration - President Trump wasted no time signing off on a range of executive orders. Toward the end of the month import tariffs were enacted against major trading partners Canada, Mexico and China – with all three vowing some form of retaliation. The US trade-weighted tariff rate on imports has risen to the highest levels since the 1940’s. Should a trade war escalate that would weigh on global growth and increase inflation. President Trump also enacted a range of measures that will impact on ESG policies and the Energy Transition, for example withdrawing from the Paris Climate Accord. Trump told OPEC to lower the oil price and encouraged US oil producers to “drill baby drill”. The “Make America great again” policies have seen the US small business optimism index rise.
Australian economy: RBA to cut in Feb? – Despite solid labour market data (4% unemployment rate), a softer inflation print saw investors price in a higher chance of a February rate cut by the RBA. Credit growth has remained strong and government spending remains supportive. The $A/$US rebounded slightly (+0.5% to 62.18c) after falling materially in the December quarter.
Commodities broadly rose – The Precious Metals index and LME (base metals) index rose 7.2% and 1.6% respectively. Iron ore rose 6%, Lithium (Spodumene) jumped another 5% while Oil gained 2%.
ASX200 earnings improving but remain expensively priced - Heading into the February reporting season, earnings revisions have been more positive. Notably, US reporting season has started solidly, and expectations are still for strong earnings growth for the year ahead. Recent $A falls may help ASX listed international industrials deliver positive surprises. However, ASX200 (price-earnings) valuation levels remain pricey at 18.3x forward earnings vs the long-term average of 15x and leave little room for disappointment. This is representative of other stock markets also (as shown in the chart below from JPMorgan). The ASX200 dividend yield of 3.3% is well below historic average levels of 4.4% and equity valuations relative to bonds also don’t look appealing. This leaves us mildly cautious and intensely focused on holding quality securities at reasonable valuations. In our view, a diversified and active approach bodes well in the current environment to protect capital but also take advantage of opportunities when they present themselves.
The chart below illustrates that some equity markets (including the ASX200 & S&P500) require higher growth rates than what are currently forecast to align current equity valuations to 10-year averages. That is, for ASX200 Price-earnings (PE) multiples to revert to historical 10-year averages, a 3-year compound average growth rate (CAGR) of 8.9% is required versus current consensus forecasts of 4.2%.
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