Looking ahead, investors should watch commodity prices, RBA/Fed interest rate decisions, evolving government subsidy policies, and (most particularly) credit spread movements. There hasn’t been a market sell-off of any substance since April, so a (hopefully minor and short-lived) correction is due.
International Shares
In the September quarter the MSCI world stock market index rose by a further 7%, continuing the strong global equity market performance of recent years.
Investors have taken a greater risk-on bias recently, led by technology and AI and some emerging markets, while macro and geopolitical issues produced some pockets of volatility. Central bank global easing bias helped, but the main market stimulant has been investor enthusiasm. Investors continue to price accelerating AI penetration which, together with upbeat guidance from several large-cap technology companies, underpinned large-cap US indices (and was a major reason the Nasdaq outperformed). Microsoft and Alphabet were visible beneficiaries of that thematic rotation.
Corporate profits in the US are proving better than previously expected, with upgrades apparent in many sectors, not just technology. Improved profits ease overvaluation concerns and help justify seemingly high fundamental market multiples. The US represents about 60% of all global stocks (and a whopping 74% of the MSCI World Index), so trends and results there have an outsized market effect globally. The US earnings trend has been strong, (so higher share prices are no surprise), but valuations on any meaningful fundamental basis are now high, perhaps even frothy, so volatility and price movement risks are elevated.
The main European indices saw moderate-to-strong advances for the quarter, the benchmark STOXX Europe 600 being up by 3.5% in EUR terms. In contrast, Germany's benchmark DAX index suffered a slight retreat, due to the export-oriented nature of the German economy facing trade and tariff threats. British shares had a good quarter, led by banks and resources, whilst French shares were also strong, notwithstanding domestic political instability.
The US-China trade relationship is weakening with more boisterous pronouncements (from both sides) critical of the policies of each other. It might not be a ‘cold war’, but it’s not too far off. President Trump’s aggressive tariff perspectives are notably focused on China, due to the US having a trade deficit. Two superpowers butting heads over trade doesn’t auger well for global economic stability and has (and will further) contribute to financial market volatility.
Geopolitical issues remain a market volatility amplifier. The long-running Middle East and Ukraine conflicts continue to represent a risk for markets, including energy (and by extension, inflation). Geopolitical news hasn’t derailed the risk rally in global markets but peaceful resolutions are very much desired.
Looking ahead, the risk-on period will probably falter temporarily, perhaps due to investor (valuation) fatigue, or perhaps something extraneous such as a credit market event. Investors are facing a later-cycle trade dilemma, keep riding the momentum in the AI, technology and commodity areas or back off to more defensive-style investment mix. It’s a good time for portfolio diversification.
Property Securities
The prices of listed Real Estate Investment Trusts (REITs) rose by 4% in the September quarter, further adding to the rally of the prior months.
REIT performance was driven by lower short-term cash rate expectations after the RBA’s August cut, softer real yields, and clearer signs of stabilisation across retail and industrial property fundamentals (leasing, occupancy and transaction activity). That macro tailwind was reinforced by solid FY25 result seasons across many listed managers and some active capital management including buybacks and dividends. Returns were concentrated on industrial, convenience retail and well-positioned shopping centre owners, while some more leveraged or fund-management-exposed names lagged.
Most REITs have completed debt refinancing or extension deals, continuing the trend towards sound capital and finance management and most have benefitted from slight reductions in interest rates.
In the retail sector higher customer visitation and stronger retail sales (helped by earlier rate relief and resilient employment) fed better retail cash flow — a tangible boost for Westfield owner Scentre and other retail landlords who reported occupancy cash flow improvements.
The commercial and office market in Australian CBD’s is generally positive for premium, high-quality assets, though the market is still working through challenges like elevated vacancy rates in some segments. But a cyclical recovery is underway, with improved demand for premium space being the dominant theme, particularly for high-quality, modern, well-located office buildings in the premium and A-grade category.
Leasing demand is expected to strengthen, driven by increased office-based business headcount and slowing new supply due to high construction costs severely constraining the development pipeline. New office supply is forecast to slow sharply, which is expected to help absorb existing inventory and drive vacancy rates lower in the coming years, underpinning rental growth in well-positioned assets.
REITs should garner further investor support If the RBA continues to ease or market pricing for cuts strengthens, especially those with low gearing and long tenancy leases. REIT market prices are also sensitive to bond yields so investors should be aware of inflation surprises and any material bond market movement.
Interest Rate
Australia’s Reserve Bank reduced the official cash interest rate by 0.25% to 3.6% in August, continuing their policy of gradual rather than rapid easing. The cash rate has now been cut three times since the cycle-peak of 4.35%.
At their September meeting the RBA chose to hold rates steady, noting in their minutes a moderately tight labour market and a pickup in house prices and credit growth. More recently, weaker underemployment and labour underutilisation data led to the unemployment rate ticking up to 4.5%, reigniting the expectation of one more 2025 rate cut.
Long bond rates meanwhile have been remarkably steady, mostly trading in a range of 4% to 4.5% for a couple of years now. The bond yield reflects supply (government borrowing), inflation, and financial stability expectations, including trends globally. There is much talk of more stressed government finances globally, with some notable pressure points such as France, where an inability to agree a more austere budget had led to political instability. Indubitably, the possibility of a sovereign borrowing program misfire represents a financial market pricing risk. There’ll come a time when financial markets revert to risk-off should governments persevere with such indifference to structural deficits and excess debt.
In the corporate fixed interest market place some investment product issuers are developing innovative security structures for retail investors, looking to fill a demand following the regulators’ ban on new bank tier-1 hybrids. Private credit products are also in abundance, some with higher-risk loan pools that investors should mostly avoid. In the United States an automotive parts business called First Brands collapsed in September with billions of liabilities hidden in opaque, off-balance sheet structures, mostly financed by private credit. The existence of such rogue financial structures should send a clamoring warning to investors, as too should the extent of leverage and margined investor loans, which are at a record high.
Looking ahead, we expect another RBA rate cut before the end of 2025, with an accompanying announcement that might hint of a cycle-end. The downwards trend in inflation might reverse, putting a bit of pressure on bonds. Credit spreads (which are very tight), might back out a bit, particularly if more negative events arise in the higher risk segments of financing. This would temporarily weaken the market prices of many corporate and credit securities.
Outlook
Economic, corporate and political news has been more favourable lately, leading to a sustained rally in risk-based asset prices. Valuations are stretching higher, and (in some subsectors) frothiness of price is morphing into bubbles. A continuation of relatively good news would keep asset prices high, but it wouldn’t take much to trigger a market correction.
In Australia, lower interest rates will remain stimulatory for markets and consumers, and government subsidies are now extending deeper into the corporate arena, notable in minerals processing.
Shares therefore should be viewed through a positive lens, but valuation fundamentals provide limited prospective near-term returns for investors, and a mild correction downwards is overdue.
Longer-term the domestic investment outlook remains sound due to a core underlying strength of our economy. Technology, notably the imposition of artificial intelligence, is an economic and social game changer so investors should hold some investment exposure in the technology sector but expect more sustained volatility.
Yours sincerely,
Malcolm Palmer
Joseph Palmer & Sons
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