Is there cause for concern as volatility returns to the share market, or might there be opportunities at hand?
The start of August has brought about a resurgence in volatility, with the US market recording some of its worst single-session results since the market crash at the start of the pandemic.
Gripped by fear, investors effectively embraced a ‘sell first, ask questions later’ approach, which led to some notable declines across the board.
We’ve often reflected on why it is important to look through the noise and focus on a long-term approach to investing. These recent events are exactly the type of ‘noise’ we refer to when we make said statement.
In fact, it is our view that the short-term volatility we are witnessing could be an opportunistic time for long-term investors to add funds and pick up some quality companies at discounted prices.
But first, let’s take a moment to go over some of the details behind recent disturbances in the share market.
What are investors worried about?
If we are to assess the opportunity at hand, we also need to acknowledge the factors that have prompted a resurgence in market volatility.
Since the start of August, two clear issues have weighed on the market.
For starters, investors have grown increasingly concerned about the prospect of a US recession in light of soft employment data.
The most-recent labour report indicated that jobs growth throughout the world’s largest economy has slowed abruptly.
In July, US non-farm payrolls rose by 114,000, whereas the consensus forecast heading into that result was an increase of 175,000 jobs.
On top of that, hiring numbers for May and June were revised lower by a combined figure of 29,000.
In terms of the bottom line result, the lacklustre jobs growth, combined with an increase in the labour participation rate, saw the unemployment rate rise from 4.1% to 4.3%.
Naturally, there are considerable implications for the economy if hiring freezes or unemployment increases.
The US economy is largely contingent on services, and ultimately, the strength of the American consumer.
Meanwhile, there was another issue brewing overseas, and it refers to something known as the ‘Japanese Yen carry trade’.
This trading strategy involves investors borrowing money in Japanese yen at low interest rates around 1% or thereabouts, before using those funds to invest in higher-yielding currencies, equities, or even bonds.
However, the Japanese Yen recently posted a sharp rally as the Bank of Japan lifted interest rates to a 15-year high. At the same time, investors are looking to the US Federal Reserve to cut rates, which is putting downward pressure on the almighty greenback.
This phenomenon started many years back, when in 2013 the Japanese government embarked on a round of quantitative and qualitative easing, depreciating the yen. At the same time, the US began lifting interest rates.
When the US Federal Reserve started its rate hike cycle in 2022 in order to quash inflation, and the Bank of Japan kept its short term rates negative, Japanese Yen carry trades grew exponentially.
Are these problems a risk to the market rally?
In our view, recent events are indicative of short-term volatility, rather than the beginning of an extended downturn.
Of the two issues in play, the Japanese Yen carry trade is more of a trading ‘shock’ instigated by institutional investors de-leveraging and disposing of equities to accommodate losses on their carry trades.
On the other hand, concerns about a US recession warrant greater scrutiny given this relates to the underlying strength of the economy.
Nonetheless, US unemployment is still relatively healthy when looking at historical levels.
Yes, the unemployment rate has increased over recent months, and it is no longer near the 50-year lows that we saw for much of 2023.
However, the long-term average for the unemployment rate is circa 5.7%, which is considerably higher than today’s level of 4.3%.
We must also exercise caution in reading too much into month-to-month data, because as we have seen, the impact of related factors like participation rate can have a profound influence on the underlying figures.
It is also no surprise that unemployment is increasing as this is one of the direct consequences of aggressive monetary tightening.
Now that it is increasingly likely the Federal Reserve will begin to cut interest rates from next month, we expect some support for the economy, and in turn, hiring.
Such effects are likely to operate with a lag, so the jobless rate could still increase some amount from current levels, but we anticipate an easing in monetary policy will provide a backstop for any extended downturn in the US economy.
Seizing long-term opportunities
With the above in mind, we are looking at current market conditions as being conducive for long-term buying.
A number of stocks are now trading at major discounts compared with just a week or two ago, and most importantly, this includes a host of well-known, quality businesses.
The sell-off has had the most pronounced impact on the tech sector, where valuations were already easing through July as some unfolding of the ‘AI trade’ occurred, and as earnings season fell short of lofty expectations.
That means companies like Microsoft (MSFT), Alphabet (GOOGL), and Amazon (AMZN) are trading around 15% off their highs at the time of writing, Apple (AAPL) is down around 10%, while Nvidia (NVDA) is more than 25% below its peak.
The opportunities extend far and wide at this time, even beyond the tech sector, however, the fact that mega-tech names have taken a hit of this magnitude in such a short time is compelling when we consider a long-term buying outlook.
At the end of the day, these businesses have a history of resilience through the economic cycle, and their exposure to high-growth investment themes means they will continue to play a key role in an increasingly digitised economy, regardless of any near-term slowdown.
International
International Growth Portfolio
Last month, NAV for the Global Growth Portfolio declined by -0.6%, which was a disappointing result for us in light of the stock market’s broader performance.
By way of comparison, the Dow Jones climbed 4.4% higher during July, the S&P 500 gained 1.1%, and the Nasdaq Composite Index declined by -0.8%.
Fortunately, we benefitted from some movements in foreign exchange currency, with the USD/AUD rate lifting from 1.4994 to 1.5287 over the month.
As it were, the underperformance of the Portfolio was largely attributable to a poor return from Crowdstrike Holdings (CRWD), which tumbled -39.5%.
The cybersecurity firm was at the centre of the worst global IT outage in history, which followed a faulty software update crashing an estimated eight and a half million computers around the globe.
Understandably, the company came in for heavy criticism in light of said event. There will also be some protracted legal battles from here, with shareholders and clients already signalling their intentions to pursue the company for compensation.
However, it is also our view that the extent of the sell-off was overdone, and that the company’s security solutions, which remain among the best-in-class, are an integral part of business’ operations right through the global economy.
Most importantly, the incident wasn’t attributable to a security breach, rather a ‘bug’, and we would expect insurance coverage, for both Crowdstrike and its clients, to pick up at least some of the potential financial liabilities that may arise.
Elsewhere, big tech results left some investors a little underwhelmed, with the likes of Alphabet (GOOGL) and Microsoft (MSFT) seeing growth in key divisions fall short of expectations. However, it is worth noting that expectations were particularly high leading into said results, as the market was trading at record levels.
There was also some evidence of an ‘unwinding’ in the AI trade, as shares like Nvidia (NVDA) and Taiwan Semiconductor Manufacturing (TSM) declined through the month. Nonetheless, we expect long-term interest to resurface, and while August has been characterised by significant market volatility, we have also seen the emergence of long-term opportunities.
At the end of July, unrealised profits represented approximately 33.8% of overall Portfolio NAV.
Portfolios Review: July 2024
The Australian share market enjoyed a bumper return through July, with the benchmark S&P/ASX 200 index surging 4.2% over the course of the month.
Investor sentiment was supported by an increasing case for rate cuts in the United States, while the local market was also shielded from tech-related weakness on account of the benchmark index holding limited exposure to that sector.
In addition, fresh Australian inflation data landed better than feared, which eased some concerns that the Reserve Bank of Australia may have been about to go in a different direction than its peers and resume hiking interest rates.
Commodity shares were one of the drags for the local market, however, with strength across most other sectors, the mood was still overwhelmingly positive in July.
Since the end of the month, market volatility has reared its head, and we expect the local market will take a lead from US shares, regardless of the composition of the ASX and results to come out of reporting season.
Australian shares outperform
In comparison with international markets, the Australian share market was one of the better performers through July.
Fundamental to this result was the performance of the Financials sector, including bank shares, which delivered strong gains for the second month in a row.
Commonwealth Bank (CBA) reset its all-time high, while the other ‘Big Four’ names achieved multi-year highs.
Over recent months, this sector has been underpinned by an improving outlook as far as getting inflation back under control.
In the US, continual progress means that the Federal Reserve is now on track to begin slashing interest rates.
This has offered encouragement to local investors on account of the implications for Australian inflation and future RBA rate cuts.
Naturally, each of our Portfolios derived a benefit from the strong performance of the ASX last month.
The BetaShares Australia 200 ETF (A200) and Betashares Australian Quality ETF (AQLT) are two of the securities we hold that offer direct exposure to the local market, with the pair yielding solid returns in July.
While the ASX has followed US shares lower in the early stages of August, it is worth noting that the market does not hold the same exposure to some of the more ‘vulnerable’ growth assets that we see in the US.
On this basis, the local market should be more shielded than the likes of the Nasdaq, which is also why we hold a slightly greater weighting to Australian shares in our Conservative and Balanced Portfolios.
Tech weighs on US markets
Typically, in a month where the ASX rises, and by a large magnitude as happened in July, we would anticipate that US markets deliver strong returns over the same period.
And while the Dow Jones had a solid month, the S&P 500 and Nasdaq Composite faced a different story, with the former up 1.1%, and the latter off the pace to the tune of -0.8%.
The reason for this was the performance of the tech sector, which was rattled through the month due to various factors.
For starters, the global IT outage arising from a Crowdstrike update ‘bug’ weighed on a handful of names and tested broader sentiment for tech shares.
By the time reporting season had wrapped up, it was also clear that some of the market’s biggest names, including Microsoft and Alphabet, among others, had fallen short of expectations.
Since then, volatility that has rocked the market has arisen from concerns about the strength of the world’s largest economy, with tech stocks proving particularly vulnerable to said concerns.
On the back of these issues, soft returns from tech-heavy US indices weighed on each of our Portfolios, albeit to different degrees.
Somewhat out of character, the High Growth and Growth Portfolios both underperformed the Conservative Portfolio, despite a rise in the local market.
Much of this boils down to our exposure in the BetaShares NASDAQ 100 ETF (NDQ) and the BetaShares NASDAQ 100-Currency Hedged ETF (HNDQ), which were directly exposed to a tech sell-off in July.
To a lesser extent, an increased weighting in the VanEck MSCI International Quality ETF (QUAL) and VanEck MSCI International Quality (Hedged) ETF (QHAL) also weighed on our more growth-oriented Portfolios.
Fixed income and hybrids provide support
Bonds and hybrids were a positive contributor towards each of the Portfolios, however, the greatest upside was recorded in the Conservative Portfolio, where our exposure to these assets is greatest.
Aside from bank hybrids related to Macquarie, Westpac, and NAB, the Vaneck 1-3 Month Us Treasury Bond ETF (TBIL) enjoyed a stellar month, rising 2.1%.
While that may seem relatively modest, bonds are deemed a defensive asset class, so this is a particularly prominent result. In fact, the ETF was back near a three-month high.
One of the central objectives of our Conservative Portfolio is to generate regular income and shield the Portfolio from excess volatility.
Our investment in TBIL is designed to offer exposure to a low-risk interest-bearing investment, whereby we can park some of our capital as we access short-term U.S. Treasury bills.
Short-duration Treasury bills are an ideal cash management strategy as we mitigate exposure to fluctuations in interest rates, which generally accompany longer-duration bonds like the BetaShares U.S. Treasury Bond 20+ Year-Currency Hedged ETF (GGOV), which we also hold.
Infrastructure returns offer encouragement
While it may not be a core component of our Portfolios, we still hold modest exposure to infrastructure as an asset class.
In July, returns from holdings like the VanEck FTSE Global Infrastructure (Hedged) ETF (IFRA) and the Vanguard Global Infrastructure Index ETF (VBLD) were particularly pleasing, up 5.2% and 8.4% respectively.
Through these holdings, we have sought targeted exposure to a diversified cohort of global infrastructure companies that typically deliver inflation-linked and regulated income.
Furthermore, most of our exposure in this asset class relates to US companies.
Last month, on the back of positive US inflation data, the odds of a September rate cut increased to near-certain levels.
In turn, this supported a rally in sub-sectors like utilities, transportation, pipelines, rail, and so forth. These segments tend to benefit as interest rates decrease because the value of these assets stand to gain as the present value of their cash flows increase.
Again, holdings like IFRA and VBLD go some way towards explaining why the Conservative Portfolio outperformed our other Portfolios in July, albeit infrastructure is an asset class that we retain exposure across the board.
Comments