Inflation, Interest Rates and Geopolitics
The themes of the quarter were dominated by inflation and interest rate expectations, and the war in Ukraine. Consequently, the biggest impact on financial markets was in bonds.
The AusBond Composite Bond Index returned -5.9% for the quarter and -5.5% for the year – the lowest returns in history. This has officially been the worst bond market selloff ever.
Rising Yields = Negative Returns for Bonds
Source: Morningstar. Data as at 31 March 2022. Bloomberg AusBond Composite 0+ Yr Index
The benchmark 10-year Australian bond yield rose to above 2.9% in the last week of March, the highest since March 2017, as expectations of higher interest rates are dumping demand for government bonds. Investors now see the Reserve Bank of Australia raising interest rates higher and faster than earlier projections.
Equity markets on the other hand have seen a roller-coaster quarter. The Australian and US stock markets recorded their worst January since the global financial crisis, on the back of rising inflation and expected slower growth. Financial markets dealt with changing economic and central bank accommodations, including the ending of Quantitative Easing (QE) programs, lower fiscal Government spending, and central banks adjusting their trajectory for interest rate rises in the face of rising inflation. The latter part of the quarter saw a rally in global equities that defied the chaos in bond markets.
Adding to the increased volatility in markets has been the conflict in Ukraine, which has accelerated the rise in energy, commodity, and food prices even further, and put pressure on the economic recovery, as the world recovers from the COVID-19 pandemic. The impact from the Ukraine conflict remains highly uncertain. While central banks are downplaying the possibility of a recession this year regardless of higher interest rates, the inversion of the US yield curve suggests the market is factoring in an economic slowdown further out.
On the 17th of March, the Federal Reserve raised interest rates in the US by 0.25% for the first time since 2018, and said it expected to keep increasing them until they hit between 1.75% and 2% by the end of the year - in a newly aggressive stance against the highest inflation in a generation. As markets had fully priced in the rate rise, the real news was in the strength of the economy which resulted in a rally in the second half of March despite the uncertainty around Ukraine.
- Due to rising yields bonds had negative returns for the quarter & year.
- The Australian equity market (S&P/ASX 200 Index) returned a modest 2.2% for the quarter but returned just over 15% for the year.
- International markets have been hit harder by the fall in tech stocks and the conflict in the Ukraine.
- Over a 10-year period the global markets have returned approximately 6% p.a. higher than Australian shares.
- Emerging Markets were down -2.5% for the quarter due to China but positive 2.9% for the year.
- Australian and Global REIT’s have had a strong quarter and strong year, rebounding from lows post the March 2020 quarter.
Enhanced Asset Class – Factor Returns
We pursue higher expected investment returns for our clients, through low-cost, highly diversified portfolios which tilt toward known factors of return. These ‘factors’ of return, when combined in a portfolio, can lead to higher expected returns.
- Small Caps returned 9.7% underperformed Large by 5.3%.
- Value outperformed the market by 1.4%
- Small Caps underperformed the market over the past 12 months by 12%.
- Value was inline with the market.
Small caps lagged large everywhere. However, there was a very strong value premium across developed and emerging markets in the quarter, leading to a slight value premium over the last 12 months.