Underlying inflation is causing global uncertainty for central banks and has become the markets' primary concern in June. Many central banks have reevaluated potential risks and have decided to increase policy rates. In response, the market has pushed yields higher and delayed any plans for easing. Short- and long-term AU government bond yields rallied aggressively in June after a relatively quiet prior month.
The Reserve Bank of Australia is carefully navigating the situation as they consider the potential risks of inflation in comparison to the economic implications of tightening monetary policy. RBA's Governor Lowe expressed concern about the inflationary impact caused by the Fair Work Commission's award wage result being higher than expected and increased inflation expectations in specific sectors. Core inflation has remained persistent globally, driven by services inflation resulting from wage growth, which has elevated the risk of longer-lasting inflation worldwide, and the RBA is not exempt from this concern.
The labour market in Australia showed strength as the unemployment rate stood at 3.6%. The economy benefited from population growth, leading to increased income. This contributed to inflation, as evidenced by the monthly CPI rising by 5.6% compared to the previous year. Services inflation remained stubbornly high.
Following the RBA’s meeting in early June, the financial markets were taken aback by the unexpectedly bullish stance. As a result, short-term money markets adjusted their expectations and began pricing in the likelihood of two additional interest rate hikes, amounting to a cash rate of approximately 4.60%. Compared to the current cash rate of 4.10%, 90-day bank bills experienced a significant increase of 37bps, reaching 4.35%. Similarly, the yields of 180-day bank bills rose by 53bps, reaching 4.70%.
June 2023 Summary
- The NASDAQ saw its best half-yearly performance on record
- A rotation into cyclical stocks saw a narrow market breadth improve in June
- US Home builders and industrials broke to fresh all-time highs in June
- Interest rate volatility pulled back to normal levels
- US Markets are now pricing another two 25bps hikes from the Fed this year
- Market sentiment is improving amid softening inflation and robust housing and jobs data
In H1, the Nasdaq 100 (NDX) experienced an impressive gain of +39.4%, enjoying its best half-yearly performance since its inception in 1985. Additionally, the NDX showed its strongest relative performance compared to the S&P 500 (+16.9%), Russell 2000 (+8.1%), and the Dow Jones Industrials (+4.9%). This strong performance by the NDX sparked concerns among pessimists about its limited leadership and lack of market breadth, mainly when both the Dow Jones Industrials and Russell 2000 remained stagnant until the end of May. However, the market's breadth improved significantly in June, as the Dow Jones Industrials (INDU), S&P 500 (SPX), and the S&P 500 equal-weight (SPW) indices all achieved their highest monthly performance in 2023.
Seven of the eleven sectors saw an increase in the first half of the year, with Technology, Communications, and Discretionary leading the way. The S&P 500 Technology Index, which is based on market capitalization, came close to reaching its previous all-time high from December 2021. However, it has since traded sideways, indicating a period of consolidation before potentially breaking through resistance. It's important to note that the Technology Index, when equally weighted, and the small-cap Russell 2000 Technology Index, also had respectable gains in the first half of the year. In mid-June, the S&P 500 Equal Weight Technology Index broke through a resistance level that had been in place for eleven months, reaching new 52-week highs. The Russell 2000 Technology Index is also approaching its eleven-month resistance level.
During the first five months of 2023, the main reasons for the strong performance were technological advancements and expansion. However, there was a noticeable shift towards cyclical industries in June, possibly indicating improved economic activity. All eleven sectors ended the month with positive gains. The sector that performed the best was Discretionary, with a 12.1% increase, driven by Tesla and Amazon. This was followed by Industrials, which saw an 11.3% increase, and Materials, which saw an 11.1% increase.
Industrials is particularly noteworthy as it not only had a strong performance in June but also continued to rise in early July, reaching new record highs that were last seen in November 2021. The strong performance in June was supported by widespread participation, with 37% of its members reaching their highest levels in the past 52 weeks.
At the beginning of the year, numerous market analysts predicted an economic downturn caused by the delayed consequences of the Federal Reserve's continuous 15-month increase in interest rates. Adding fuel to the fire of a possible shortage of credit was the disturbance in the banking sector in March when four American banks and one European bank collapsed. The resulting instability in interest rates reached levels not seen since the global financial crisis; however, the MOVE Index has been gradually declining and returning to normal levels, partly because of the introduction of new measures to enhance liquidity by regulatory authorities. The decrease in bond instability is beneficial for overall market liquidity.
US GDP for Q1 was revised upwards to 2% from 1.3%, with exports and consumer spending being the main drivers. Consumer confidence has been boosted, reaching its highest level since the beginning of 2022. This rise can be attributed to the strong labour market and the easing of inflation. The unemployment rate in May is still very low, matching the lowest levels seen in generations, and there has been an increase in the number of jobs in the residential construction sector. As seen in the core CPI and PPI, inflation is slowing down, but the Federal Reserve's preferred measurement, the core PCE, has remained high.
The resolution to raise the debt ceiling caused worries that the resulting increase in debt issuance would deplete liquidity from the market, sparking more volatility and a decline in asset prices. However, the Federal Reserve's reduction of longer-term bonds through quantitative tightening, coupled with the majority of newly issued bonds being shorter-term Treasury bills, which money market funds mostly took up, has mitigated these concerns. The increase in short-term Treasury bill issuance and the subsequent decrease in the duration of bonds in the system may be pushing investors to take on more risk.
Q2 company profits are predicted to fall for the third consecutive quarter. FactSet reports that the estimated decrease in earnings for the S&P 500 is 6.8%, which would be the most significant decrease since Q2 2020. The S&P 500's P/E ratio over the next 12 months is 18.9, compared to the 5-year and 10-year averages of 18.6 and 17.4, respectively.
The Federal Reserve did not increase interest rates at the June meeting, but policymakers have forecast two more rate hikes this year. The market is anticipating a rate hike at the upcoming July meeting, with a 40% chance of an additional quarter-point hike. In the past, the possibility of more rate hikes caused a decline in asset prices throughout 2022. However, Chair Powell has recently made more hawkish public statements, even though asset prices have remained stable.
The markets are factoring in a more positive economic outlook than the media and market experts have been stating and predicting. The indexes have reached historic highs, the market breadth is improving, the industrial and homebuilder sectors are experiencing new peaks, the economic data is showing resilience, inflation is decreasing, corporate earnings are expected to improve in the second half of the year, and the potential impact of artificial intelligence revolution may indicate that the highly desired recession might not occur this year as initially anticipated.