The ASX200 was down over 6% in January, domestic small caps followed, down over 9%.
Global markets were not spared either with markets down anywhere from 2-5% depending upon the A$ currency exposure.
Bond Markets & Cash Rates
Bond markets were sold off throughout the course of January on the back of significant moves in bond yields. This was seen particularly at the front end of the curve as investors began to anticipate that central banks will start increasing cash rates throughout the first half of this year.
This was on the back of some significant CPI figures, with inflation now over 7% in the US. It is our expectation that the Fed will aggressively start to move rates higher, starting with a 0.5% rise in official cash rating in March.
This has had a flow on implication for financial performance, particularly equity markets and those sectors that are more interest rate sensitive.
Geopolitical Issues Impacting Markets
The conflict in Europe is causing uncertainty in financial markets. At this stage, we don’t believe that these conflicts will impact central bank decision making, particularly in the US. However, investors’ nerves have shone through in some parts of the market throughout the course of January and into early February.
We believe that this instability will continue to drive markets over the medium term.
ASX Reporting Season
As we head into the first half of the February reporting season, we do not see the performance that we saw through the first half of 2021 being repeated. Earnings growth is likely to moderate given where it has come over the last 12 months.
That said, we do expect to see some reasonable results from some of the more quality names that we have across our portfolios such as Macquarie Group (MQG) and James Hardie (JHX) to name a few.
On the commodity side, we have seen solid performance over the last 12 months with oil and other core commodities moving higher. We expect this to translate into good performance numbers across some of the major miners on that basis.
We have not materially altered our asset allocation over the course of the month, but we are looking to take risk off the table and have added more defensive plays right across our portfolios given the current market backdrop.
We are expecting central banks to start to move in March and that is going to be led by the US Fed. This will have implications no doubt for financial markets over the next few months.
We are still of the view that the RBA is going to take a more cautious stance as it relates to rising cash rates despite seeing an uptick in domestic inflation numbers.
Our view is that inflation is currently at the upper end of that 2-3% band that the RBA is targeting (unlike what we are seeing in the US, where inflation is much higher than central bank’s target levels), so we don’t expect that this should result in RBA being overly aggressive in the way they position the cash rate in the 1H22. That said, there is a potential for cash rates to rise through the back half of this year, but it would depend on how inflation looks through the second half of this year.
Overall, it has been a really challenging month for investors after a very strong 2021. We think this year is going to be more volatile and is likely to prove to be a difficult one for investors. We will be looking to reduce risk as much as we can and focus on quality within the construct of our portfolios as a means of mitigating those downside risk issues.
Piers Bolger is Chief Investment Officer at Viridian Advisory.
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