Brief Summary of the Market Environment

This summary reviews the financial year just ended - 2023/2024 - and then seeks to place this financial year in the context of the period since 1 January 2022 (when the current inflation outbreak commenced) - causing the volatility we have experience over the last few financial years.

The good news is that this is the second consecutive financial year to have delivered positive returns for long term investors - after the negative returns experienced in the 2021/2022 and 2019/2020 financial years.

2023/2024 in review

Markets - always darkest before dawn

The year comprised a clear tale of two 'halves'.

The first - from July 2023 to November 2023 being weighed down by ongoing Inflation / Interest rate / recession fears, with the Gaza / Israel situation seriously undermining confidence In October and November; and

The second, from December 2023 through June 2024 reflecting developing confidence that inflation is under control, that a soft landing (I.e. no recession) is likely, and that the next move in interest rates is more likely down than up - with uncertainty as to when the rate cutting cycle might commence. Naturally, it helped that the Gaza conflict didn’t metastasize into a regional war.

Most of the uplift occurred between November and March - with markets fluctuating through April and June - affected by the changing inflation / interest rate / growth / recession outlook from time to time. Geopolitical and global (and US) election outlooks appear to have been of lesser consequence to markets.

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The Chart above shows the performance of US / Australian / Global shares / the top 100 companies listed on the Nasdaq (predominantly the larger technology, communications and healthcare companies); and Global Fixed Interest Securities. A - D are regarded as "Growth" assets, whereas E is regarded as being "Defensive"

In addition to the tale of two halves, the stories within the story comprised tales of: large companies vs small companies, technology companies vs other companies, the US vs everywhere else, macroeconomics vs geopolitical risk.

The main driver of equity (share) market returns has been the performance of a few large, US listed technology companies. The top 10 US listed shares now account for approximately 37% of the value of the total of the top 500 US listed companies (the S&P 500 index).

The so-called "Magnificent Seven" of Apple, Amazon, Alphabet, Meta, Microsoft, Nvidia and Tesla make of 31% of the index and returned approximately 55% over the Financial Year.

Clearly, the other 493 companies didn’t do that well if the S&P 500 'only' delivered 24% over the year.

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In the chart above, Global FANG is a fair proxy for the performance of the Magnificent Seven, and the Russell 2000 is a fair proxy for global small companies.

So, returns have not been broad based, and concentrated portfolios constructed by stock pickers and market timers would have been materially affected by the inclusion or omission, and extent of investment, in any one of the '7'.

Portfolio returns

For broadly diversified portfolios, the mix of Growth and Defensive assets will be the primary determinant of the returns for the year.

Higher allocations to Australian shares and Fixed Interest securities would suppress achieved returns, whereas higher allocations to the Nasdaq, US or Global Shares would elevate achieved returns.

Growth Portfolios

Growth portfolios are regarded as portfolios with 70% to 80% invested in growth assets and 20% to 30% in defensive assets. The Future Fund and some of the "Balanced" investment options associated with industry super funds would fall into this category.

Future Fund returns for the period ending 30 June 2024 are not yet available - but as of 31 March 2024 the Fund had returned 8.3% after costs for the nine month period of the year.

Most industry superfunds have reported full year results for their "Balanced" (read "Growth") investment options for 2023/24. These vary between 5% and 10 % after all fees and taxes.

Industry funds tend to have material exposures to unlisted assets such as direct property, infrastructure and private equity - which have seen valuations slowly adjusting downwards as the reality of cash rates at 5% has taken effect. In addition, of their listed share allocations - they tend to have a material, sometimes equal weight allocation to Australian vs international shares.

Balanced Portfolios

Balanced portfolios are regarded as portfolios with 50 to 60% invested in growth assets, and 40% to 50% in defensive assets.

Reported Industry super fund "Conservative Balanced / Conservative Growth / Moderate" investment options delivered returns of 4% to 7% for the year.

FY 2023/24 in context

During the Covid pandemic in 2020 and 2021 supply chains were seriously disrupted, while governments worldwide provide massive amounts of financial support to businesses and consumers in order stimulate the economy and prevent another Great Depression.

The initial response was entirely appropriate - but the level of fiscal stimulation was sustained for far too long, with household savings rates rocketing (as people were unable to spend during lockdown).

By the end of 2021 it became apparent that curtailed supply (supply chain issues) and excessive demand ('revenge' spending) were creating inflationary pressures in the economy. In January 2022 the full effect of the current inflationary outburst became apparent, only to be exacerbated by the Russia/Ukraine war and severe Covid lockdowns in China.

Markets had to quickly absorb the fact that 14 years of cheap money and low inflation had come to an end, and markets fell heavily between January and June 2022 - with continuing volatility throughout FY 2022 / 2023 - all the way through to October / November 2023.

• In December 2021 bank term deposits were paying interest of approximately 0.4% pa and home mortgages were available under 2% per annum. Now these are around 5% and 6.25% pa respectively.
• In April 2022 the RBA rate was 0.1% pa. In November 2023 it was 4.35%pa - mirroring global developments.

The pace and extent of these increases is historic, and we remain surprised (and relieved) that greater economic disruption in the form of a severe recession and significant unemployment was not the result.

The inflationary disruption and uncertainty is reflected clearly in the below chart - from 1 January 22 to 31 October 2023. The Hamas attack on 7 October added geopolitical risk to the equation - during October 2023.

Almost 2 years had passed in which portfolios had done little but experienced a roller coaster ride.

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Dawn arrives

Throughout this period, we have educated clients that 'this too shall pass'.

Nevertheless, October 2023 was a testing time for many investors; and we observed a few clients experiencing the emotions associated with the downdraft of the market cycle.

In late October, early November 2023 inflation readings across the globe provided confirmation that inflation was largely under control, that economies were performing reasonably well, that corporate earnings may in fact grow, and that the next move in interest rates would be down - and soon.

And markets responded accordingly.

In fact, the run up has been so material and so quick it almost seems as if we have jumped to the 'Thrill" or "Euphoria" part of the cycle of emotions!

In October 23 some clients were inclined to move to cash. Now we have clients wanting to go 'all-in' on the Magnificent Seven. Buying high and selling low is not a great investment strategy.

FY 2023 /24 can best be viewed through the lens of the period 1 January 2022 through 30 June 2024 reflected in the chart on the page below.

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Outlook for 2024/2025

Recognising that new information is immediately incorporated into market prices - we can only evaluate what might happen in the coming year with the information at our disposal today. This is trite of course - but we have no way of forecasting the major events of the coming year. These are unknown unknowns.

The known knowns are already factored into market prices - as these are always forward looking. These are:

• Trump will likely win the US election and his de-regulation and reduced taxes policies are likely good for company earnings - in the short term.
• Decreased US taxes will add to an already problematic US fiscal debt and deficit problem - but markets are not presently concerned.
• Trump's tariff policies are inherently inflationary - especially if these provoke retaliatory tariffs by other countries.
• The global economy - while slowing - remains strong and the company earnings outlook is positive.
• The global economy - while slowing - remains strong and the company earnings outlook is positive.
• Expected future returns are a function of the starting point. Where the starting point is at a high - expected returns are lower than they would have been had the starting point been at a low.

The known unknowns include:

• To what extent might a second Trump presidency spell the end of the Pax Americana, or the Rules-based order?
• The Middle East situation.
• Whether the US elections deliver a clean sweep of the Presidency, the House and the Senate to the Republicans.
• The impact of AI on productivity.
• When / if markets will impose discipline on profligate governments globally.

We know that past performance cannot be relied upon as a predictor of future performance. Looking forward at the next 12 months and based on current market prices, we would expect muted share market returns, and good single digit returns in excess of bank deposit interest - from high credit quality, fixed and floating interest securities.

There is a probability of high levels of volatility associated with equity prices - as any disappointing inflation / growth / unemployment reading may undermine market confidence significantly. And longer duration fixed interest securities may disappoint - if: US: tariff policy comes to fruition / is more extreme than anticipated / provokes retaliation; or the market finally no longer accepts continuing expansion of debt and deficits and adds a risk premium (higher yield requirement) to US treasuries.

In summary

We do not prognosticate, but with the information available today - and noting the elevated geopolitical risk– it feels as if:

• Equities appear expensive and may experience some volatility if any inflation / interest rate disappointment arises.
  • On balance there appears to be more downside risk than upside risk.
• High credit quality floating interest rate securities may continue to deliver reasonable relative returns.
  • On balance there appears to be more upside risk than downside risk.
• High Credit Quality Fixed interest rate securities may deliver good, single digit returns – with the extent of these returns being negatively impacted by higher inflation / delayed interest rate reductions / a developing aversion to US Treasuries based on perceived risk.
• Unlisted assets are likely to continue to see valuations falling through the year - as this readjustment has yet to complete.
• We do not expect any return or liquidity surprises associated with the larger non-bank lenders– but keep an eye out on bank arrears as an indication of the arrears outlook for non-bank lenders. This point in the cycle is when lending books are under the most pressure.

Warnings:

The information provided in this communication is of a general nature only and does not take into account your personal objectives, financial situation, or needs. Before acting on any information, you should consider its appropriateness having regard to your own circumstances and seek independent financial advice from a qualified professional.

Past performance cannot be relied upon as a predictor of future performance.

Our outlooks are not a prediction. Actual outcomes may be different from those suggested in this commentary.