• Overall global equity market sentiment remains solid despite continued heavy selling of software stocks.

• US dollar weakness, higher local interest rates and selected commodity price strength pushed the $A higher.

• Bond yields edged higher ahead of RBA interest rate decision.

International Equities

Global Share Market Monthly Returns (%)

Global equity markets continued to advance over January, with the global developed market average increasing 1.7%. There was mixed performance across the regions, with the United States (up 1.5%) slightly under performing. Contributing to this under performance was the technology sector, which fell 4.2%. Weakness in the technology sector was heavily concentrated in software stocks, with concerns that artificial intelligence advancements would reduce the intrinsic value of existing software businesses (as programming costs decline) becoming increasingly dominant. Amongst the largest U.S. stocks, Microsoft was the most impacted by the software concerns, declining 11.0% over the month.

In contrast to software, the energy sector surged higher due to a 13.6% jump in the global crude oil price. Concerns over escalating geopolitical risk between the United States and Iran, combined with a spike in shorter term demand due to adverse weather conditions across the Northern Hemisphere, contributed to the lift in the oil price. The United Kingdom share market, with a strong energy company presence, was a beneficiary, increasing by 3.1% over the month. Share markets were more subdued across Europe though, with both Germany and France finishing flat for the month.

Asian markets outperformed over January. Japan’s Nikki 225 Index rallied 5.9%, as investors became increasingly confident that a snap election would bolster the Prime Minister’s pro-growth and government spending stance. There was also a recovery on the Chinese share market, which combined with continued computer chip and semi-conductor related strength in Korea and Taiwan, resulted in particularly strong gains in emerging market investments. India (down 2.9%) though, continued to underperform.

Despite slightly higher bond yields in the U.S. last month, there was staunch support for global listed infrastructure (up 3.8%) and property (up 2.8%). Australian listed property, however, was weaker by 2.7%, with the strong expectation of a February interest rate increase detracting demand for the sector. On an annual basis, Australian listed property is now the weakest of the major asset classes, returning just 2.0%.

Australian Equities

ASX Key Sectors % Monthly Change

Source: S&P ASX

The Australian share market finished closely in line with the global average over January, with the S&P ASX 200 Index advancing 1.8%. Once again, the resource sector was a major contributor, rising 10.0% for the month. Although there was a softening in the iron ore price, ongoing strength in precious metal and copper prices boosted sentiment across the resource sector. Gold prices were 18.9% higher over the month, despite an 8.5% pull-back on the final trading day of the month. As was the case globally, higher oil prices resulted in the energy stocks being well supported, with the sector advancing 10.6% over January.

Also consistent with the global pattern was a further decline in technology stocks, with the sector falling 9.4% over the month, bringing the quarterly decline to 26.9%. With the Australian technology sector being heavily software orientated, the sector correction has been particularly large. Banking stocks also detracted from Australian market returns, with a resumption in the rotation away from the Commonwealth Bank (down 7.0%) having a significant impact. Over the past 6 months, the CBA has returned negative 14.8%, whereas all 3 other major banks have produced positive returns.

Fixed Interest & Currencies

There was little movement on bond markets over January, with central bank policy decisions being in line with market expectations. The U.S. Federal Reserve kept cash interest rates unchanged in January, following a reduction in December. As expected, the Australian Reserve Bank lifted the cash rate by 0.25% to 3.85% following their Board meeting in early February. Australia’s 10-year Government bond yield rose by just 0.06% to 4.80% over January, with the U.S. equivalent 10-year yield rising by the same margin to 4.26%. Credit markets continued to deliver positive returns, although there has been some escalation in concern over bank and private debt exposures to the software sector.

$A / $US Exchange Rate

The Australian currency was well supported over January, which possibly reflected a combination of higher local interest rate expectations, strength in selected commodity prices and broader weakness in the U.S. dollar. Geopolitical events did contribute to a lower $US, with concerns over the U.S. Government’s position in relation to Greenland, and their action in Venezuela, weighing on the currency. These concerns did, however, ease late in the month. None-the-less, against the $US, the $A finished the month U.S. 3.1 cents higher at U.S. 70.0 cents. The $A was also stronger relative to the Euro (up 3.0%) and the Japanese Yen (up 2.8%). Due to the appreciation in the Australian currency, returns on unhedged global equity investments were negative over January.

Outlook and Portfolio Positioning

It was a highly eventful start to the new calendar year. Although broad asset class returns in January were unexceptional, there was significant movement within specific equity market sectors,  commodity markets and currencies over January. The size of these movements demonstrates a highly reactionary mood across markets, which potentially leads to a more volatile period ahead  – where risk management and diversification of investment style take on greater importance.

The size of the sell-off in software stocks over recent weeks is one example of the current “restlessness” of markets, which has seen the local technology sector fall by 30% in value since early November. Both the timing and magnitude of this correction is hard to reconcile, given that the alleged threat posed by artificial intelligence (AI) to software businesses has been known for some time. For active managers, this type of market movement creates opportunity, with the local profit reporting season in February shaping up as being more important than most in either challenging or corroborating the logic of recent price trends. The technology sell-off also signals a significant shift in market leadership, implying that strategies and approaches that were successful over the AI focussed rally of the past 3 years may be less rewarding in the year ahead.

Outside of equity markets, there has also been substantial sentiment swings in commodity and currency markets. Much of the recent movements in these markets appears to originate from changing views around the outlook for the United States dollar. Periods of concern over U.S. debt, central bank independence or broader geopolitical stability, have been associated with a declining $US and surging gold (and silver) price. However, the calming impact of the nomination of Kevin Warsh as the next Chair of the U.S. Federal Reserve saw a sharp reversal in the precious metal and currency trends in late January and early February. Again, the magnitude of swings in these markets could have significant implications for investors. These recent patterns point to a need to understand all underlying portfolio risk exposures, including the $US exposure that comes courtesy of holding global equities on an unhedged currency basis.

While the $US and gold price are acting as a barometer of sentiment around the outlook for stability in the U.S. financial system, surprisingly U.S. Treasury Bonds seem immune from the same bouts of concern. Steady support for U.S. bonds has resulted in yields remaining relatively low, particularly in light of the fact the U.S. economy is yet to achieve the central bank’s inflation target. Given the low yields on offer in the U.S., and the reality of some of the concerns that have influenced currency and gold markets over recent quarters, the current pricing on U.S. bonds appears unattractive. In contrast, Australian bonds, where yields are materially higher and risks arguably lower, stand out as offering value.

Despite the large swings within selected markets over recent weeks, there remains a preparedness by investors to support equity markets, which have continued to grind higher. With the global economy remaining robust, financial system liquidity and corporate balance sheets strong, and company earnings continuing to the expand, the logic of maintaining healthy exposures to equity markets remains in place. However, if January is any guide, small variances in positioning and risk exposures within markets could lead to significant divergence in investment outcomes in the months ahead.

Important Information

The following indexes are used to report asset class performance: ASX S&P 200 Index, MSCI World Index ex Australia net AUD TR, MSCI World ex Australia NR Hdg AUD, FTSE EPRA/NAREIT Developed REITs Index Net TRI AUD Hedged, Bloomberg AusBond Composite 0 Yr Index, Barclays Global Aggregate ($A Hedged), Bloomberg AusBond Bank Bill Index, S&P ASX 300 A-REIT (Sector) TR Index AUD, S&P Global Infrastructure NR Index (AUD Hedged), MSCI China (Composite) in CN, Deutsche Borse DAX 30 Performance TR in EU. Hang Seng TR in HKD, MSCI United Kingdom TR in GBP, Nikkei 225 in JPY, S&P 500 TR in USD.

General Advice Disclaimer

Any advice contained in this document is of a general nature only and does not take in to account the objectives, financial situation or needs of any particular person. Any decision to invest in products mentioned in this document should only be made after reviewing the relevant Product Disclosure Statements. Past performance is not a reliable indicator of future performance. Varria Pty Ltd  is an authorised representative of Charter Financial Planning ABN 35 002 976 294 AFSL number 234665