The June quarter produced a number of interesting events for Australians.

We saw a Labor Government take power at a Federal level following a landslide election win. Furthermore, a significant number of Liberal seats were won by independent candidates which speaks in volumes to the Australian public’s demand for change and their dissatisfaction with the previous governments’ status quo.

In the same quarter inflation reared its ugly head. This is something we had been anticipating for a number of months. However, have only recently started experiencing conditions which warrant the use of tighter monetary policy leavers. These rising inflationary pressures have somewhat caught the Reserve Bank of Australia off guard as, in January 2022, they had expected to experience a period of low inflation and plateauing domestic rates at current levels well into 2024. However, by May 2022 we saw our first rate rise in 12 years with an increase of 0.25%. This has since been followed by two more increases of 0.50% in both June and July. The official rate now sits at 1.35% which is the highest it has been since May 2019.

Rising rates have created volatile equity markets which have suited our short term overweight cash position and offered good conditions to identify new opportunities. The rate raises in Australia are reflected globally with all major economies increasing their central bank cash rates. Interesting, for the first time in 8 years, all major G7 economies now have positive yield curves. Most significantly, Japan, has transitioned to a positive return on cash which is not something that has been experienced for close to a decade.

The major take outs from this quarter are: 

• Inflation: World economies continue to navigate through rising inflationary pressures which have been building for the last 12 months, particularly in Europe. The UK has faces particularly inflationary issues resulting from their ongoing energy crisis and created by a number of supply side issues. A major contributor to these supply side constraints are the restrictions created by leaving the European Union with no meaningful free trade agreements. This issue is far from resolved for this major economy.
• Policy makers are starting to tighten Fiscal and Monetary Policy to focus on managing inflation. Inflationary pressures have been exacerbated by an extended period of access to cheap money for consumer. There is a direct correlation to consumer spending and ultimately economic activity. Rates are rising and now it’s a balancing act between economic growth and keeping inflation within the RBA’s target.
• Labour markets around the world are strengthening. The US labour market has continued to show strong signs of growth in June which illustrates that increasing inflation has slowed the demand for labour.
• Consumer confidence has been falling in the US for some time and that is now starting to show in Australia. A key driver of this slowdown is the increase in inflation and the subsequent rise in the cost of living.
• In the Australian market we have experience one of our biggest spikes in GDP growth and inflation since the 1980s. The biggest contributors to GDP growth have been private based consumption and government spending.
• The positive takeaway from this analysis is the lack of capital expenditure undertaken by companies over the past 2 years. We anticipate this means companies will maintain strong balance sheets and should be well positioned to ride out any economic weakness.
• An area of concern is Government spending which as a percentage of GDP, is the highest it has been in decades.
• The US faces its highest inflationary pressures in 30 years and a tight labour market. This will weigh on GDP growth over the coming months. The major contributors to inflation have been food and energy costs. These are expected to persist.
• Markets are still priced very high compared to long term averages. We think we will see most markets fall slightly more before becoming a meaningful buying opportunity.
• While the current indicators in Australia start to look more moderate, we recommend caution as these indicators tend to be lagging and more opportunities will present as uncertainty increases.
• Fixed interest markets have experienced one of the hardest periods over the past 30 or 40 years. With bond rates increasing, this has placed pressure on the currently issued rates causing them to be revalued by investors.
• Height Capital’s view is that rates are now fully priced over the medium term. We anticipate the bond market has over corrected and now expect to see the market stabilise. Reserve banks globally will reduce their hawkish outlook close to the end of the year. Our expectation is that they will they overshoot the mark and need to drop rates within the next 12 months to support falling economies – watch this space.
• Equity markets have all reverted towards the long-term trendline. This is what we have been anticipating for at least the last 6 months given with the expectation that rates would increase. Now, most markets will stabilise in the short term while looking for indicators that earnings won’t fall in line with markets. Should this be the case we will see a bounce in markets.

Our key strategy points are:

• Purchase quality mature business with sustainable cash flow and strong balance sheets. The key objective is to take current market opportunities to pick up high quality businesses while prices is soft.
• A key risk of this market is the overexposure to the property market as it comes off. We want to be careful of earning reductions from slowing economies and asset class corrections.
• Fixed interest has now become more attractive with fixed rate bonds falling under face value. We see this as an opportunity to purchase 2 year bonds at 5% plus a 5% capital appreciation back to face value at maturity.

For the more detailed report or to receive these updates on a quarterly basis, please email info@heightcapital.com.au