It’s been another interesting month for financial markets in October as equity markets moved higher, while bond markets, particularly our domestic bond market struggled to deliver.
Australian Fixed Income
The domestic fixed income market saw the biggest single month decline since February 2021 (-3.6%). This was driven by higher inflationary expectations and the move by the Reserve Bank Australia (RBA) to abandon Yield Curve Control (YCC) at the front end of the curve.
Bond yields were up 90 basis points at the 3-year part of the curve. This flowed through to the 10-year part of the curve, which was up over 60 basis points throughout the month.
Inflationary pressures have pushed bond yields higher over the last 3-6 months domestically and globally, resulting in negative absolute performance for both. This has particularly affected the local market in the past 12 months, with yields up over 1% at the short and long end of the curve.
On the contrary, equity markets are all higher over the last 12 months with some markets up over 30% on the back of a post pandemic recovery. However, for the month of October local equity markets were flat, following the decline in the domestic fixed income market, with the energy, consumer staples and industrial sectors all lower.
Global equities were generally higher with the hedged global equities up over 5.5% for October. This was assisted by a 4% uplift in the Australian dollar against the US dollar. Unhedged global equities were also stronger up 1.5-2%. Overall, developed markets were up, strongly led by US S&P500 (+6.9%) and NASDAQ (+7.3%) indices. European markets were also stronger.
The only lagging global market was emerging markets which were down -2.9% over the month. EM equities were lower on the back of growth concerns out of China and the regulatory pivot which is impacting foreign capital inflows and broader market sentiment to emerging markets.
However, when looking at emerging markets compared to developed markets, the relative valuations are becoming quite compelling. Emerging market equities are now at a material discount (-40%) to developed market (S&P500 index) equities. This is a significant divergence from the usual 10-15% discount.
While emerging markets continue to provide a solid opportunity set, we have maintained our underweight position given the ongoing issues in China.
We’re also maintaining a short duration position in fixed income, as well as introducing more flexible strategies into the portfolio as we continue to refine our positioning into 2022.
Central Banks and Cash Rates
Our core view remains that bond yields will continue to move higher as central banks begin their tapering programs and as official cash rates may also start to move higher through the back end of 2022 into 2023.
Even though the Reserve Bank Australia (RBA) has noted that there’s no change to its policy as it relates to hiking cash rates, we do believe there is a potential for higher domestic cash rates to occur sometime in 2023.
Inflationary pressures continue to build, leading central banks to begin exploring the tapering of QE programs. This shift will have broader implications for financial markets, particularly bond markets as yields are expected to rise through the latter stages of 2021 into 2022 and beyond.
Piers Bolger is Chief Investment Officer at Viridian Advisory.
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