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November 2022 - Performance, Commentary, Updates

Link to full Update

Commentary

Equities managed to build on the October strength into November with global markets rising and Australian equities performing strongly with strength across financials and resources. The surprise pivot from the RBA in October and 25 basis point rise in November has given hope that central bank tightening, more broadly can slow.

The RBA can perhaps afford to let inflation run at the higher end of its target range (2-3%), as long as wage growth does not accelerate higher in coming quarters, and longer-run inflation expectations remain broadly within the 2-3% range. At a minimum, the RBA senses it has some time to assess. The market has the cash rate peaking between 3.5-4.0%, with rises likely through March 2023 (25bps). And the RBA will have in the back of its mind the impact of a possible US recession in 2023. And the job is not made easy for the RBA with a slump in consumer confidence and a surge in short-term consumer inflation expectations during the month. In Australia, data remained mixed and consistent with yet another 0.25% RBA rate hike next month. The September quarter wage price index rose slightly more than expected 1.0% (market 0.9%), with private sector wages up 1.2%. We have to consider that the wage gain last quarter in part reflects the 5% increase in minimum award wages given to the 20% of the workers. If you strip this out, wages look pretty stable.

In the US the FED raised rates by 75bps as expected, the surprise was that it hinted it could moderate the pace of rises and 50bps (or even 25bps) could be possible going forward. Markets liked this. However, the FED was quick to emphasise that the peak in the cash rate could go higher than the ~5.0% level that it projected back in September. In summary, a mixed message of slowing the pace of rises but ultimately rate might go higher than you expect. It's a signal they don't think inflation is contained, and they are uncomfortable with wage growth and the unemployment rate is so low.

The US CPI came in less than expected, and core inflation (excluding food and energy) rose by only 0.3% over the month compared with market expectations of 0.5%. After a recent string of misses to the upside, this was welcome by markets. While goods inflation is becoming contained, services inflation is more challenging. For the FED knows that it is difficult to contain services inflation without driving a material slowdown in consumer spending and employment demand. Bringing both of these lower without pushing the economy into recession is close to impossible if we look at recent history.

The key caution for markets is while a US recession is widely discussed, is it priced in? We think that is a key risk, a scenario by which markets have to rapidly downgrade earnings, and the market PE contracts at the same time. Further, the FED has been operating Quantitative Tightening (QT) for the last few months this and has a strong correlation with lowering the market PE (and vice versa). If we look at the performance of oil over the month, it is also signaling concern over an economic slowdown. A positive is that there are some signals that China will now walk back on its Covid zero policy and reopen the economy.

We continue to take the view that it is too early to price in a FED pivot (3rd pivot rally of the year), without pricing the consequences of aggressive tightening. The evidence for a continuing bear market in equities is ongoing and strong. Key monetary metrics continue to shrink, and the yield curve remains strongly inverted. In recessionary bear markets, the yield curve typically steepens before the bear market has finished, and this has not occurred yet. Accordingly, we sold into the equity strength in November, reducing equity exposure domestic and international (in high growth) and continued to average into the bond exposure (primarily US treasuries). We also added to gold exposure in High Growth.

All the best for 2023,

Tom

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