‘Small caps are back’ may well have been the headline for global equity markets in August. In the US, headline market indices, the S&P 500 and Nasdaq Composite, rose 2.0% and 1.6% respectively but the limelight belonged to the Russell 2000, which measures the performance of all US companies outside the largest 1000, and that collection of companies rose 7.0% over the month.
The story was similar in Australia with gains in the ASX 200 of 2.6% dwarfed by the 8.2% rise in the XSO (Australian Small Companies) with small cap resources +13.5%, think gold stocks, and small industrials up 6.1%. The Australian Gold Miners Index rose 20%.
Asian equity markets also performed strongly with the Japanese Nikkei 225 Index +4.0% and the Shanghai Composite +8.0% in response to an improving Chinese economy.
The NZ share market lagged its offshore peers with a gain of 0.8% bringing year on year returns to just 2.6%. Anecdotal evidence suggests the housing market may have bottomed and with further support likely from lower interest rates, an uptick in residential property could breathe life into our otherwise sluggish economy.
Broader risk indicators in August were supportive for equities, with volatility in both equity and bond indexes falling, high yield and investment grade credit spreads narrowing and the interest rate market pricing further cash rate reductions from the Federal Reserve, the RBA and the RBNZ.
While broadly, volatility was lower across equity markets, Regal noted that in the Australian market “Results Day’ volatility reached unprecedented levels during the August reporting season.
UBS analysts put the higher volatility down to structural factors such as rising passive ownership and the increased prevalence of quant driven strategies, where algorithms drive trades and can exacerbate moves in both directions. Others put it down to high valuations leaving little room for disappointments. The trend shown in the chart below, could be used to support both views.
While the share price moves were extraordinary, profits have been fairly ordinary. According to Morningstar’s Lochlan Halloway, share prices across the ASX 200 have risen 40% since mid-2022 while earnings have basically done nothing, in fact for the largest companies, have gone backwards.
FTSE Russell’s Julia Lee said the price to earnings ratio has risen from 18-times earnings a year ago to 22-times today.
This comes at a time when valuations in developed equity markets are stretched (see P/E All World below), and bond markets are flashing ‘red’. The 30 year German government bond yield rose 5 basis points to a 30-year high. French bonds surged amid more political wrangling, and Japan’s 30-year government bond yield continues to scale all-time highs on the back of rising inflation.
With bond indices much shorter in duration than 30 years, more around 6-7 years, lower cash rates in August, projected to go lower again, led to gains in NZ and global bonds as can be seen in the ‘returns table’ above. However, the message from the longer dated yields is that all is not well.
Nowhere was this message louder and clearer than in Britian, where 30-year gilts (UK government bonds) jumped to 5.7%, a 27 year high, as investors ponder the dilemma of weak growth, burgeoning government debt and persistent inflation.
Another sign investors are looking to ‘hedge’ their equity and bond bets is the strong performance of gold, which has surged through US$3,500 an ounce. With geo-political risks front of house, government finances in poor shape, a trade war in full swing and economic growth weakening, it is unsurprising that investors are turning to gold which is considered a safe haven in times of stress and an inflation hedge.
If you’d like to discuss how global market shifts impact your portfolio, please get in touch with Mark or Sam.