A look back at last month and an outlook for the months ahead

What we liked

  • Australian monthly CPI read came in at 2.7%, lower than the 2.8% expected. This shows further progress in reducing inflation and is supportive for a potential rate cuts.
  • The US Federal Reserve cut rates by 0.5%, which was at the upper end of expectations. The central bank also indicated it had shifted its focus from inflation to supporting employment, which is expected to be a medium-term positive to stimulate the US domestic economy.
  • The economic activity in the US service sector expanded at a moderate pace in August, with the ISM Services PMI edging higher to 51.5 from 51.4 in July. This reading came in above the market expectation of 51.1. The services sector makes up around 80% of economic activity in the US.
  • US employers added 142,000 jobs last month, just shy of the 163,000 consensus new jobs expected. While a miss the unemployment rate dropped from 4.3% to 4.2%, which remains supportive for consumption growth in the US.
  • US inflation through the headline CPI, a broad measure of goods and services costs across the U.S. economy fell to 2.55, below the 2.6% expected. This is the lowest level since February 2021.
  • UK retail sales were strong increasing by 1% month on month versus the 0.4% expected. This is encouraging as we continue to see signs of the UK economy rebounding from its sluggish economic growth rates seen in the past two years.
  • China’s latest slew of monetary support measures ranging from outsized rate cuts to aid for its stock market, in a move that encouraged investors. While not expected to return the Chinese economy to target growth alone, we view it as an encouraging stimulus package.

What we didn’t

  • The RBA in its meeting minutes maintained a hawkish (bias to higher interest rates) stance. This is despite many Australians with large mortgages feeling the pinch from higher rates and pulling back on discretionary spending.
  • Job openings in the US, a measure of labour demand, had fallen by 237,000 to 7.673 million on the last day of July, the lowest level since January 2021. While it shows a slowing employment market the job opening levels are returning to long-term normal levels, following labour shortages in the US in the post-COVID period.
  • The US ISM manufacturing report showed that economic activity in the US manufacturing sector contracted in August for the fifth consecutive month and the 21st time in the last 22 months. ISM’s Manufacturing PMI has come in at 47.2 percent for August, up from the 46.8 percent recorded in July, but still below 50 points – indicating a contraction.
  • Chinese Manufacturing PMI’s remain on the weak side, with the NBS Manufacturing PMI missing expectations. The read came in at 49.1 versus 49.5 expected. Somewhat mitigating this was a better read from the CAIXIN manufacturing PMI, which measures activity in small to medium enterprises. This beat expectations with a read of 50.4, showing expansion.
  • Chinese retail sales and industrial production grew, but both missed expectations. This data exhibits continued struggles within the Chinese domestic economy to return to target growth rates.

Base Case

Our view of the most likely scenario for markets over the coming months, for which our portfolios are currently positioned.

75% Probability

A cautious view on global growth over the short-term prevails, as global economic data continues to come in mixed. While the U.S. remains the clear economic outperformer over the past two years vs the rest of the world, we may begin to see other regions show some relative improvement. This is expected to further catalyse due to recent interest rate cuts in the US creating a weaker USD. This tends to be stimulatory for global growth as much of the worlds debt is priced in USD, so in many ways a global interest rate cut.

Our view remains that inflation is expected to continue moderating, although to remain above averages from the past decade. In isolation, this should be supportive for credit markets as well as valuations of growth assets and manifest in greater financial market stability over the medium-term. This is likely to be mitigated by weaker earnings in some sectors, as lower inflationary pressures and impacts from higher interest rates puts pressure on interest rate sensitive company/sector earnings and lower income household balance sheets.

The current environment leaves central banks, particularly the U.S. Federal Reserve, in a difficult position. Developed economy central bank choices appear to be to ease financial conditions thus supporting the economy and financial system, while risking local currency weakness, higher bond yields and inflation or continue to fight inflation and risk more severe economic weakness and potential bond market/banking stress. The actions of policy makers to move in either direction will be a large driver of financial market performance over the coming months. The recent moves in lowering rates in the US communicate that the central bank has chosen the growth and supporting employment market route. This is constructive for economic activity and risk asset performance, in particular monetary inflation hedges such as precious metals.

The sequencing of these events will be important. We continue to expect heightened market volatility due to slowing economic, progression towards the US Presidential election and entering a seasonally weak period for markets (September/October). Despite this, we expect that any volatility will lead to further liquidity injection from central banks to shore up the financial system. Positively, liquidity has begun to trend higher over the past month and is expected to continue to grow over the second half of 2024. This is expected to provide continued support for financial markets over the medium-term.

This scenario is likely to see us maintain a positive view on growth assets over the medium-term, although more defensive sector weightings may be warranted over the coming few months. As previously stated, we expect bouts of volatility to emerge as market positioning and sentiment has been very strong, increasing the possibility of growth fears or exogenous shocks adversely impacting markets. As an example, some U.S. regional banks balance sheets remain at risk, should interest rates and rate volatility remain high.

Further weakening in employment leading indicators, or if we see central banks reducing their efforts to provide liquidity into financial markets would lead to this more defensive positioning. Overall, asset allocation will retain a bias to growth assets, with short-term tactical positioning to be guided by macroeconomic developments and central bank actions.

Bear Case

Our worst-case scenario for the coming months, which we are prepared to position for should conditions deteriorate.

11% Probability

Global consumer demand for goods and services falls further than expected, with US growth faltering and the rest of the world showing no sign of improvement from tepid recent growth. Inflationary pressures and elevated interest rates negatively impact discretionary spending, further placing pressure on economic activity. A reversion to bank stresses seen earlier this year would be expected to further tighten bank lending standards also. This could act to place pressure on the currently very strong global employment conditions.

Geopolitical tensions could act to negatively impact supply chain bottle necks and energy prices, further exacerbating inflationary pressures and placing greater pressure on central banks to tighten monetary and financial conditions. Additionally, wage pressures and higher cost of lodging become more systemic as employees successfully lobby for wage increases. This will lead to a deterioration in company profits as increased input costs, and debt servicing costs (from higher interest rates) combined with lower demand converge to crimp company earnings.

Such a scenario would result in a tightening of financial conditions, while inflationary pressures remain elevated. This could see central banks continuing to withdraw monetary support (through higher interest rates) at a time when the economy is weakening. Additionally, an untimely withdrawal or reduction of central bank liquidity into the financial system could derail financial markets, which have become accustomed to liquidity support. When combined with reduced government expenditure, due to elevated indebtedness, this may cause consumer confidence and spending to fall, as prior government support is not fully replaced by gainful employment income.

Rapid escalation in geo-political tensions or a significant or systemic credit default, due to over-indebtedness in an environment of rising bond yields and elevated volatility in financial asset prices, could see a liquidation of risk assets within a compressed period. Such a situation would see us move rapidly and meaningfully into cash at the expense of equities. Further to this, the recent stresses seen in globally systemically important banks could lead to more bouts of liquidity events, which would be expected to have a pronounced negative effect on economic growth.

Above scenarios will see us take a more defensive position and reduce equity exposures replacing them with defensive assets, such as cash. The accelerating bond yield scenario would require a more nuanced shift toward companies and sectors that would be the greatest beneficiaries of such a move. Focus will be on a more defensive posture with capital preservation being the primary objective. A further shift towards defensive sectors such as healthcare, consumer staples and utilities would combine with higher cash levels in this scenario.

Bull case

Our most optimistic view for markets over the coming months.

14% Probability

Economies across the developed world experience better than anticipated economic growth rates. When combined with waning inflationary pressures, as supply chain bottlenecks ease and productivity levels improve, we would expect a virtuous pro-growth asset environment as interest rate pressures subside. Additionally, current global conflicts remain contained. In this scenario disposable income for consumers would increase as inputs costs for corporates reduce. The result would be resilient earnings growth for companies as economic growth accelerates and costs are contained.

Fiscal support from governments could combine with sound cash levels on household and corporate balance sheets to accelerate the speed of the global economic recovery. In the event central banks resume measures aimed at suppressing interest rates below inflation levels and potentially adding further liquidity enhancement measures to support financial systems, we would expect this to further fuel asset prices.

This scenario would be very positive for financial markets as improving financial conditions act to fuel demand for growth assets in a low to negative real interest rate environment. We would act by ensuring a growth asset bias with low cash levels. Additionally, if leading economic indicators began surprising to the upside a net shift towards cyclical sectors leveraged to economic growth would occur.

Stock in Focus – REA Group

Investment Thesis

REA Group (REA) is a leading global digital business, specialising in property sales and marketing and is the owner of the market leading Realestate.com.au property portal in Australia but also similar services in the US, India and Asia. REA is an impressive growth story with a strong track record or earnings and share price growth with innovative management that continue to develop new high margin products and services for customers and have cemented themselves as an integral part of the residential and commercial property transaction markets. With a view to positioning for a future lower interest rate cycle, we took advantage of a pull back in September make an initial investment in REA Group

History

REA Group Limited was incorporated in 1995 and is headquartered in Richmond, Australia. REA Group Limited operates as a subsidiary of News Corporation. The company shares trade on the ASX and have a total market capitalisation of ~$25.5B.

REA Group Limited, together with its subsidiaries, engages in online property advertising business in Australia, India, the United States, Malaysia, Singapore, Thailand, Vietnam, and internationally. It provides property and property-related services on websites and mobile applications. The company operates residential, commercial, and share property sites, such as realestate.com.au, realcommercial.com.au, flatmates.com.au, property.com.au, housing.com, makaan.com, proptiger.com, and realtor.com. It is also involved in the provision of mortgage brokerage and home financing solutions; property data services; mortgage application and e-lodgement solutions for the broking and lending industries; commercial real estate information and technology; and vendor paid advertising and home preparation finance solutions. The company was formerly known as realestate.com.au Ltd. and changed its name to REA Group Limited in December 2008.

Saward Dawson Wealth Advisors Pty Ltd, a Corporate Authorised Representative of Akambo Pty Ltd t/a Accountants Private Advice

The information presented in this publication is general information only, and is not intended to be financial product advice. It has not been prepared taking into account your investment objectives, financial situation or needs, and should not be used as the basis for making an investment decision. Before making any investment decision you need to consider (with your financial adviser) your particular investment needs, objectives and financial circumstances.

Some numerical figures in this publication have been subject to rounding adjustments. Akambo Pty Ltd (including any of its directors, officers or employees) will not accept liability for any loss or damage as a result of any reliance on this information. The market commentary reflect Akambo Pty Ltd’s views and beliefs at the time of preparation, which are subject to change without notice.