Investment markets generally had a strong start to the year following double digit losses in some major equity and bond markets in 2022. Overall, our Balanced growth investment option (the MySuper option) returned 4.47% during the March 2023 quarter.
In the first half of the quarter, markets rallied, in part due to China shifting away from its Covid-zero policy. This gave investors hope that the global economy would receive a welcome boost and supply chain issues would be reduced. However, equity markets took a turn when the US released its January inflation numbers, which were higher than expected. Combined with a tighter-than-anticipated labour market, investors were concerned that the US Federal Reserve would tighten monetary policy more than had previously been expected.
As interest rates continued to rise, some US regional banks began losing the confidence of their customers, reflecting factors such as a significant mismatch between their assets and liabilities. For some of these banks, the sharp increase in interest rates resulted in a substantial decrease in the values of their long-term assets, such as US government bonds. Consequently, some depositors withdrew their funds fearing some banks would fail. This issue was more pronounced for banks with a higher proportion of uninsured deposits, as well as those concentrated in the technology industry, which was also experiencing a sharp downturn.
To prevent a larger banking crisis, the US government guaranteed deposits in two of the three banks that failed and provided generous borrowing terms that enabled banks to source liquidity at short notice. This policy action was very important in reducing the impact of the US banking problems. As the banking system continued to experience some strain, the market reduced the likelihood of additional rate hikes by the US Federal Reserve, as stabilising the financial system became the primary focus.
The interest rate rises over the past year or so had a negative impact on the Australian property market. According to CoreLogic, the Australian national home value fell by 8% over the year to March 2023. However, there was an increase of 0.6% in March 2023, which was the first month-on-month rise since April 2022. The main contributing factors to the recent improvements were low stock levels and a tight rental market. The outlook for housing supply remains uncertain as several construction companies have collapsed in recent months, such as Porter Davis, the 12th largest home builder, and Lloyd Group, a company that specialises in building schools and government infrastructure. The reasons for these failures included rising material costs, delays in supply chains and labour shortages.
Outlook
The failure of three US banks in a short space of time has resulted in markets switching focus from inflation to the health of the US financial system. Fixed income markets are pricing the US banking problems as a material hit to the global growth outlook that is likely to reduce inflation pressures. Expectations about the Fed have shifted materially, with markets now pricing interest rate cuts in the second half of this year. The banking problems are likely to tighten US conditions further from a level that is already consistent with the US entering a recession in 2023. Other leading indicators also suggest a US recession is likely. We also expect that US inflation will fall relatively quickly later this year reflecting the lagging impact of weaker growth.
There is a wide range of potential outcomes for equity markets over the next 12 months. In our central case, we expect that the trough in equity markets has not yet been realised, with that likely to occur in 2023. This is because the peak impact of higher interest rates on earnings is likely to be near the end of 2023, with the equity market pricing that a few months before it occurs. The main upside risk to our central case is the US avoiding a recession and inflation falling faster than the market currently expects. On the downside, the main risk is that the global economy is more sensitive to the interest rate increases than the consensus currently believes. We continue to monitor the outlook closely.
Investment returns are not guaranteed. Past performance is not a reliable indicator of future returns.
Issued by Vision Super Pty Ltd ABN 50 082 924 561 AFSL 225054. This information is general advice which does not take into account your personal financial objectives, situation or needs. Before making a decision about Vision Super, you should think about your financial requirements and consider the relevant Product Disclosure Statement and Target Market Determinations.