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- Equities and bonds, which often move in opposite directions, both finished in the red—an occurrence not seen since the first quarter of 2018.
- Commodity prices surged, with oil finishing up 33%. Energy-related assets also performed well.
- At its worst levels, the Morningstar US Market Index was down 13.6% from its peak. It then rallied back 8.9% from its lows by the end of the quarter. Stocks with high exposure to energy companies fared better, while emerging markets had a difficult quarter.
- Bonds had their worst quarter in 20 years, especially for longer-dated bonds, amid high inflation and rising interest rates.
The first quarter of 2022 was marred by Russia’s invasion of the Ukraine. Supply impacts, sanctions, companies exiting their Russian business and the ongoing doubt about Putin’s position in the Ukraine wreaked havoc on financial markets. Aside from Russian stocks and the Ruble crashing, the other notable move in markets over the quarter was across commodities – oil, gas, and agricultural commodities were all extremely volatile.
Inflation continued its upward trajectory from the fourth quarter in 2021 with the situation in the U.S. clearly becoming less transitory, posing the challenge to the Federal Reserve (and indeed other central banks) of balancing inflation and supporting the economy with looming recessionary risks and the geopolitical situation mentioned above. Nonetheless, the Fed raised its target rate by 0.25% in line with expectations with several additional increases all but certain throughout 2022. The Bank of England again raised their policy rate twice in the first quarter by 0.25% each time, whilst the European Central Bank continued to concentrate on tapering asset purchases as part of the pandemic emergency purchase program (PEPP) and didn’t move their policy rate.
The MSCI World Ex-Australia NR Index retreated -4.8% over the quarter in local currency terms, reducing the 12 month return to 11.5%. In Australian dollar terms quarterly returns were -8.4% due to the rising Australian dollar, while currency movements were negligible against the 12-month returns (+11.6%) for unhedged investors.
Energy was the standout positive performer over the quarter, returning 31.2% in local currency terms. Both Materials and Utilities were also positive, albeit marginally, returning 3.1% and 2.0% in local currency terms, respectively. All remaining sectors returned in the red over the quarter: Financials (-1.1%), Consumer Staples (-2.7%), Health Care (-2.8%), Industrials (-5.0%), Real Estate (-5.4%), Consumer Discretionary (-9.9%), I.T. (-9.9%), and Communication Services (-10.0%), all measured in local currency terms.
US shares ended the quarter returning -4.6% in local currency terms. The Federal Reserve noted again the strength of several economic activity indicators in the U.S., with job gains and the unemployment rate continuing to fall, though implications from Russia’s invasion of the Ukraine remain uncertain Over 12 months, US shares returned 15.7%. Europe ex-UK and the UK returned 4.7% and 19.0% in local currency terms, respectively.
Australian shares were relatively flat over the quarter, with the ASX200 index returning 2.2%, supported by Energy, Materials and Utilities which returned 28.3%, 15.2% and 14.1%, respectively.
Key stats (ASX 200) (12-month returns in brackets): +2.2% (+15.0%).
Bond yields increased over the quarter (the US 10-year bond yield finished the quarter around 1.82%), with the inflation scenario in the US looking a lot less transitory than once thought. This saw declines in the global benchmark index.
Key stats in local currency terms, (12-month returns in brackets): Australia: -5.9% (-5.5%); Global: -6.2% (-6.4%).
Global property & infrastructure
Domestic and global listed infrastructure sold off alongside global equities, albeit less severely than the most sectors.
Key stats (in AUD terms) (12-month returns in brackets): Australian listed property: -6.7% (+19.1%); Global listed property: -3.5% (+16%); Global listed infrastructure: +3.1% (+14%).
The US dollar depreciated against most major currencies, a somewhat unusual movement given the level which cash rates are being priced currently.
Changes to the Balanced Portfolio over the March quarter
- The fund maintained its exposure to risk assets over the quarter.
- In domestic equities, we realised some profits within Australian financials, moving further underweight
- In International equities there was quite a bit of movement: we reduced exposure to the US banks after some very strong performance, we initiated an exposure in Brazil, China and South Korea adding to the emerging market allocation, European banks were purchased, and more diversity was added to the US consumer staples allocation
- As always, we are seeking to remain opportunistic and focus on market segments with embedded value whilst being considerate of valuations in several developed markets that are expensive relative to history.
Positioning and Outlook
From the opening days of 2022, investors were taken on a wild ride during a first quarter that featured wide swings in stock, bond and commodity markets around the world. Stocks took a dive as the market reassessed the potential of the Federal Reserve setting out a more aggressive path for interest-rate hikes to help curb inflation that hit a 40-year high. Bond prices slid, sending yields higher. In a knock-on effect of rising yields, some of the stock market’s strongest performers in recent years saw share prices fall sharply.
Rising inflation and the invasion of Ukraine were the primary drivers of the pullbacks. For consumers, inflation is increasing faster than wages and is putting pressure on spending plans. Many businesses are facing higher costs for materials, and the war in Ukraine put additional pressure on supply chains that had only just started to untangle in the wake of the COVID crisis. Higher energy prices ranked among the most visible threats. The price for oil rose above $100 per barrel of West Texas Intermediate crude, up around 70% from a year ago. The Consumer Price Index, a key measure of inflation, jumped in the developed world, with U.S. CPI hitting 7.9% in the 12-month period ending February 2022. In response, central banks announced what it anticipates will be several interest-rate hikes to come this year.
Stocks fell heavily, but made a late recovery to mitigate the pain, marking the first quarterly loss since the COVID-pandemic shook up markets in early 2020. Volatility showed itself in the number of big up or down days, where the quarter was over twice as volatile as the median quarter over the past three years.
Communications services, consumer discretionary, and technology were the worst-performing sectors, while energy surged. Weak stock markets in Germany and Italy held back Europe, while commodity producers helped markets in Australia and the United Kingdom post gains.
Value-oriented stocks posted its best quarter of relative performance compared to their growth equivalents since the depths of the dot-com bubble in 2002. In the U.S., the Morningstar Value Index was up 2.3%, while Growth fell 12.0%. Having more energy exposure and less consumer discretionary helped Value outperform, but a broad shift from value to growth within sectors accounted for most of the difference, with the most notable gaps coming in healthcare, consumer staples, and financials.
Emerging markets had a difficult quarter. Russian stocks, which were 3.5% of the index to start the year, became untradeable after the invasion of Ukraine. Chinese stocks sold off for a combination of reasons, including worries about a COVID spike, an economic slowdown, and a broader reassessment of geopolitical risk. Emerging market debt also fell for similar reasons.
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