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Interest rates – gradual lift likely
Long-term bond yields lifted notably last month, with the U.S. 10-year rate rising 0.15pp to 1.07%. Australian 10-year bond yields rose 16pp to 1.13%, with the 10-year spread remaining steady at around 6pp. Rising yields saw the Bloomberg AusBond Composite Index decline 0.4% in January, to be down 0.8% from its recent month-end peak at end-October 2020.
As evident in the charts below, there has been no material change in market expectations for cash rates in the year ahead. Based on our modelling, the recent rise in bond yields is more a case of longer-term rates moving back to be more in line with fundamentals (based on current market policy expectations) after extreme risk-off moves last year. Long-term bond yields remain below pre-COVID levels.
With inflation expected to remain stubbornly low, my base case expectation is for Australian (and U.S.) policy rates to remain on hold this year, and the market to end the year still expecting no policy tightening in 2022. That would be consistent with both U.S. and Australian 10-year bond yields ending the year only modestly above current levels at around 1.25%.
Australian dollar – firm for now but should ease
Despite continued strength in iron-ore prices, the Australian dollar edged 0.6% lower against the $US last month to US76.44c, reflecting broader global strength in the $US. Based on current fundamentals, our modelling suggests fair value for the $A is around US81c, so in our view further strength in the short-term is likely.
My year-end $A target is a bit lower than current levels at around US74c, however, based on an expected 5% strengthening in the $US and a decline in iron-ore prices to around US$85/tonne. Expected $US appreciation is based on a relatively strong U.S. economic growth outlook (underpinned by major further fiscal stimulus) and a reassertion of the outperformance of U.S. favoured technology/growth sectors globally as the year progresses. I also continue to anticipate a pull back in iron-ore prices as China eases back on policy stimulus and Brazilian supply further recovers.
Equity prices – earnings-driven recovery
The S&P/ASX 200 Index inched ahead by 0.3% in January, despite a solid 6.4% increase in forward earnings. This meant the PE ratio edged back further to 19.2, from a recent month-end peak of 21.8 at end-August. Current market expectations imply 6% growth in forward earnings by year-end, though there appears scope for further upgrades due to the faster than generally expected turnaround in the economy. With bond yields only expected to rise modestly further, and the earnings-to-bond yield gap close to recent averages at around 4%, PE valuations may not need to correct back all that much over the coming year. All up, my year-end S&P/ASX 200 target is 7,000 points, or 6% above end-January levels.
Equity trends – U.S./growth vs. non-U.S./value?
The maturing global equity rebound has seen more beaten-up ‘value’ parts of the global market attract interest, although consumer and technology stocks also remain relatively strong. At a regional level, Japan and emerging markets are edging out the U.S. while Europe and Australia continue to underperform. Smalls caps have rebounded strongly, along with tentative signs of relative improvement in financials and energy. The overall rotation to value over growth stocks since mid/late 2020, however, has paused in the past two months. These recent trends have come at the expense of previous strongly performing themes such as quality and health care, while the relative performance of high yield/low volatility themes continues to languish.
Tables ordered by 6/12 month return performance for each region, sector and factor respectively – on a local currency basis. Past performance is not indicative of future performance of any index or fund. You cannot invest directly in an index. Does not take into account any fund fees and costs.
As seen in the table below, these trends are reflected in the performance of BetaShares’ thematic global and Australian equity ETFs.
Tables ordered by 6/12 month return performance for each region, sector and factor respectively. Past performance is not indicative of future performance of any index or fund. You cannot invest directly in an index. Index performance doesn’t take into account any fund fees and costs.
Among the global currency-unhedged funds, tech-related ASIA , HACK and RBTZ remain the top three relative performers. Also noteworthy is that India (IIND) has produced solid returns in recent months and is displaying a positive relative performance trend along with our actively managed emerging markets exposure (EMMG).
*Trend: Outright trend is up if the relevant NAV return index is above its 12-month moving average and the slope of the moving average is positive, and down if the index is below this moving average and the slope of the moving average is negative. No trend is displayed in all other cases. Relative trend is based on the ratio of the relevant return index to its broader Australian or global benchmark index.
**The ranking of performance is based on an equally-weighted average of 6 & 12 month return performance. A short-term ranking is also provided based on equally-weighted 3 and 6 month returns.
***Where both currency-hedged and unhedged global equity funds are available, the analysis focuses only on the currency-hedged fund performance.