It was another solid month for financial market performance this July, with both equity and bond markets moving higher over the course of the month.
Local Equity Market
Local Equity Markets were up over 1%, with the equity rally driven by uptick in the Materials Sector which was up 7.1% in the month of July.
Bond markets also rallied strongly, as yields continued to decline over the course of the month. At the back end of the curve, Australian 10-year bond yields were down around 35 basis points while the US 10-year bond yield was also down roughly 25 basis points.
Global Equities were also higher, up around 1% along with the REIT and Infrastructure sectors, which also moved higher assisted by an improving economic environment as well as benefitting from lower bond yields.
However, emerging markets equities declined over the month, down -4.5%. Emerging Markets were weaker on the back of the changing regulatory environment in China that impacted EM markets with companies such as Alibaba and Tencent particularly hard hit. Education stocks also lower on the back of the decision by Chinese authorities to curb the influence of the (for profit) education sector, particularly as it related to after school tutoring . The decision by the Chinese government resulted in the Shanghai Composite being down over 6%, while the Hang Seng Index was down 9.5% for the month.
We expect emerging markets to be remain pressure in the near term on the back of these policy changes, as China makes up a significant portion of the overall index and is the dominant market within the Asian region. Accordingly, we have reduced the extent of our overweight exposure to emerging markets until we see greater clarity on what these regulatory changes mean for individual sectors as well as individual corporates that dominate the market.
However, given the drop in emerging markets and Chinese equities particularly, the relative P/E ratio discount to developed markets has increased. To this extent, we continue to see medium term growth opportunities in emerging markets and while these policy shifts are disconcerting, we don’t believe that the Chinese government is seeking to derail the growth outlook for the economy.
The rally in bond yields is also a little surprising given that inflationary pressures remain elevated on the back of ongoing logistic and supply chain challenges.
And while we expect that the current level of inflation will moderate over time, we do expect to see some level of permanency in the recent uplift in inflationary expectations given the recent supply shock combined with the impact that the Delta variant is having on the speed of the global economic recovery. To this end, we feel that current inflationary expectations may be higher than what has been anticipated (or priced) by some market participants.
However, this doesn’t change our thinking around central bank policies in the near term, as we believe that they will continue to be cautious in the way they look to change their monetary policy settings, whether it be through the tapering of their QE programs or raising official cash rates.
Accordingly, when we look at 10-year bond yields at both a local and global level, which are both around 1.2%, we don’t feel that inflationary pressures and the growth rebound that we expect to see is being adequately priced in.
From that perspective, we’re continuing to look at our fixed income exposure, particularly as it relates to global aggregate benchmarks and continue to be underweight the sector.
On our Capital Markets valuation matrix bonds are still the most expensive they’ve been in the last 10- years and therefore, we remain underweight that part of the market.
On the flipside, we continue to focus on having an overweight allocation to growth assets across our portfolios.
Whilst the Covid-19 Delta variant is creating its own challenges both domestically and globally, we continue to believe that the growth outlook over the medium term remains relatively sound, which should be positive for growth assets.
Piers Bolger is Chief Investment Officer at Viridian Advisory.
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