Markets ended up a few percent last week, but only after a mid-week earnings scare triggered by a flat result and weak guidance from Microsoft. This week markets have been a little volatile but flat overall, leaving most markets up 5-10% for January. So far, the dominant (and very positive) themes so far this year have been all about moderation, specifically that of inflation and economic growth. The inflation part is obvious, as receding inflation pressures from supply side factors such as energy and traded goods are universally a positive thing, and something which investors hope will lead to lower rates - which is particularly important given how much debt there is around. The hopes of the market vis-a-vis economic growth are more nuanced, as too much growth would again put upwards pressure on wages, services inflation and ultimately interest rates. A hard recession, like going to the dentist, is not something anyone is going to look forward to, even if it is deemed necessary. So, the prospect of a soft recession is the new goldilocks and the thing that markets are now pinning their hopes on.  

Generally, the US earnings season has, as expected, got off to a lacklustre start. However, many companies have still managed to inch above dismal expectations, while investors remain on tenterhooks about the prospects for later in 2023. Forward guidance therefore becomes the swing factor, and this is why the market reacted so negatively to Microsoft’s okay results and dour outlook. Happily though, the macro-backdrop has been subtly improving, and there were a few 4th quarter data points that came out last week which pointed to better-than-expected economic resilience. GDP figures published last Thursday suggested the US economy is slowing, but not precipitously so. While labour markets remain tight, the latest inflation gauge (the US Fed’s preferred Personal Consumption Expenditures report) released on Friday was as benign as could be expected. Traded goods inflation continues to decline, while services inflation was flat across most categories. There is also increasing optimism that China will forge ahead with its ambitious reopening strategy, which conveniently means the Chinese economy might well be in a position to pick up the slack if and when the US economy slows more appreciably later in 2023. This is about as good an outcome as the Fed and investors could hope for right now, and increases the chance of a soft landing.

Meanwhile in Australia, the inflation numbers for the last quarter, also published last week, were higher than most expected, even if slightly lower than the RBA had forecast. The trimmed mean measure (which removes the most volatile items) was up by 1.7% (7% on an annualised basis) and just a touch down from the previous quarter. Bond yields jumped around 0.3-0.4% across the yield curve, but that got them back to just where they had been only a few weeks ago. During the past two years the Australian economy has tracked behind the US by about 6 months and if that script continues then the RBA might succeed in having the Fed do the hard lifting without having to break the local housing market. So far inflation does not appear to be waning in the way that it has in the US, and a resurgent Chinese economy could yet put a spanner in the works. Either way it will be a close-run thing, but the RBA remains optimistic and just today confirmed that they believe that last week’s 4th quarter inflation print marked peak inflation. It’s a brave call but if they pull it off they will have won back a lot of credibility, and for now the market believes them. The graph below shows how Australia and the US have managed to achieve the policies that their domestic property markets in particular have required. Most mortgages in the US are fixed on long term rates and the rapid tightening cycle that the US (and arguably world) economy needed has so far had a limited impact on the all-important housing market. Meanwhile, the RBA has somehow managed to keep rates much lower. For once, imagining the counterfactual (what would have happened if the RBA had been forced to hike as aggressively as the US) is not too difficult.

The graph also shows that medium and long-term rates were down by almost 0.5% here and overseas, which pretty much explains why the Nasdaq was up 10% in January despite slowing revenues amongst the large large tech stocks, some very public lay-offs and a worsening profit outlook. European and Asian indices were also up by a similar amount, also helped by Chinese reopening, while Japan, Australia and the UK were all up by around 5% for the month. Commodities markets (ex-energy) have also been strong this year, not least iron ore, and the three largest local miners accounted for almost half of the ASX’s gain, with the large banks also posting strong high single digit returns, which actually left the rest of the universe looking a little lacklustre. There were some notable exceptions in the consumer staples and discretionary sectors including James Hardie, Woolworths, Wesfarmers and Aristocrat Leisure. Real estate trusts also enjoyed the less dour economic outlook and pros less interest rate rise, with industrials like Goodman Group up by almost 15%, while the office and retail sectors were a little more subdued.  

‍Lastly, it was also a much better month for bond investors, with government bond portfolios clawing back 2-3% and corporate bond investors also benefitting from tighter credit spreads that reflect the likelihood of a less severe 2023 recession.