The early months of 2025 have been chaotic for investment markets due to the flurry of policy pronouncements (and counter-pronouncements) from the United States’ new administration and the sense that the world order may become less comfortable.
The imposition (or threat) of new or increased tariffs in the United States is the primary cause of market volatility. Donald Trump has long believed in tariffs as an effective component of fiscal strategy, a stance that is notably contrary to a more free-trade ideology held by most of the rest of the world for much of the last century. Trump seems determined to persevere with a higher-tariff agenda notwithstanding some push-back, as evidenced by recent market reactions.
The primary risk of higher tariffs is heightened and sustained inflation, particularly should other nations reciprocate, and a trade war develop. Such a scenario might dampen domestic consumption and lead to a trend-decline in economic activity, or even a recession. Indeed, many economic forecasters are already dialing back their 2026 projections for global economic growth.
But Donald Trump is a very unusual political character, seemingly indifferent to making contradictory pronouncements, or vacillating one way or another. Hence much of the rhetoric is nothing more than bluster – position setting for a deal – and many of the more outrageous policies are unlikely to proceed. You see, the United States (and the world) don’t want an economic recession, and Trump and his administration will ultimately do whatever they can to avoid one.
Behind the scenes in the US lurks a nasty-looking fiscal position. The US Congressional Budget Office (an agency like our Treasury) publishes forward data that contains a projection of close to US$2 trillion of annual deficits and public sector debt of a stonking $52trillion by 2035. This ultimately needs to be addressed, so the Trump chainsaw approach to cost cutting has some grounds. But I can’t help but think this to be a flawed approach with only minimal savings offset by widespread society malcontent.
If the US really wishes to address their fiscal deficit, they should tighten the public sector/private sector nexus. For example, we reviewed the financial accounts of Alphabet (Google) recently and noted current assets of about US$163 billion, of which nearly US$100 billion is cash! The point is, America Inc. is extremely profitable and wealthy – wealth that could be better distributed throughout corporate and sovereign society - and it for this reason that we don’t fret too much about their financial future, nor get too agitated by the antics of Trump.
Australian Shares
The Australian stock market, as measured by the S&P ASX200 Index, fell by 3.9% in the March quarter, though many companies traded ex-dividend during the period. The weak market was caused by a combination of relatively insipid growth in half-year corporate earnings, softness in some export commodity prices, and particularly the cascading effect of market turmoil in the United States.
Energy sector shares have been notably weak, affected by production increases in the US and elsewhere, which pressured the global oil price. Geopolitical uncertainty hasn’t helped, especially the situation in the Ukraine and Russia, and whether energy infrastructure would flow with lesser constraint – or not. Locally, Woodside has been seeking government approval to extend their key North West Shelf project, but the application has been subject to unreasonably long delays, now pushed aside till after the federal election. Such political based obfuscation and delays does not bode well for Australia’s global standing as a key provider of energy and commodities.
The inflationary impact on operational costs and wages featured prominently in management business outlook statements for 2025. Businesses with large payrolls and constrained revenue growth have seen operating margins crimped whilst more capital light businesses have been less affected. Investors have preferred consumer defensive stocks recently - a bit of a flight to quality – helping supermarket, utility and telco shares to mostly defy the weak market.
The Australian economy continues to exhibit some mixed signs. Overall, our domestic GDP is struggling to stay much above zero, most components being subdued, with the notable exception of government spending. Our outlook is clouded by the US/China tariff imbroglio as we have a particularly large trading relationship with China. But consumer spending remains satisfactory - surprisingly strong in hospitality and consistent in core retail and services sectors. The employment outlook is also satisfactory, so this period will probably represent a bottoming of a shallow economic cycle, with better times ahead.
Whilst it’s hard to visualise during this time of tariff turmoil, it’s likely that Australia will be a long-term beneficiary of the world order change due to our political and economic stability, and our strong base material and services sectors.
Our stock market, having taken a tumble, is now priced satisfactorily for investors. We consider probable investment returns based on the profits and dividends of large corporations to now modestly exceed the risk adjusted return requirement (this being the risk-free government bond yield plus the equity risk premium). Consequently, share investors with a long-term perspective can comfortably invest, though selection of stocks or sectors and the specific timing requires a watchful approach during a volatile phase.
International Shares
In the March quarter the MSCI world stock market index fell marginally by 2.1%, a relatively modest overall decline bookended by strong performance in Europe and a tumultuous decline of 10.4% in the tech-heavy US Nasdaq index.
US shares were fully or overpriced by many measures during 2024, so a correction was inevitable. It just needed a catalyst, and this was provided in spades by President Trump’s chaotic proclamations, culminating in his self-titled ‘liberation’ day display – demonstrably an embarrassing show of futile anti-diplomacy in every sense.
The shake out of US share prices has market and economic analysts scurrying to their spreadsheets, adjusting (then counter adjusting) forward earnings, cash flow and trade data with little semblance of order or definitive guidance. Little wonder markets have been volatile. But lower share prices mean better value, and many US corporations remain the most profitable and investable in the world, so investors shouldn’t fret – indeed some sectors and stocks now represent a compelling opportunity.
In Europe, the Union is emerging from a lackluster economic phase with more collective enthusiasm, and this has led to an outperformance by European stocks so far in 2025. It’s likely that the more protectionist stance in America will be beneficial to Europe, as they persevere with less cross-border trade constraints. European politics too is becoming more vocal and reformist, which in the absence of anything too radical, should position Europe more favourably in the Trump piloted new world order.
The Australian dollar recently fell, then rose again, against the US dollar cross. Rapid recent movements in our currency have primarily been driven by US centric events rather than the usual commodity price, terms-of-trade and relative interest rate reasons. The recently higher Australian dollar improves the investment metrics for Australians investing in American shares, but our dollar remains very weak against European currencies, thereby detracting from the investment case for that region.
Property Securities
The prices of listed Real Estate Investment Trusts (REITs) fell by 7.3% in the March quarter, this was on top of the December quarter’s 7% decline. Much of the large sectoral fall can be attributed to Goodman Group, the sector’s dominant stock, which enjoyed a momentum (not fundamental) based strong share price rally last year but tumbled 20% last quarter back to a more justifiable valuation.
Commercial property valuations have now stabilised, as bond yield interest rates (a key measure for determining capitalisation rates for valuation) have settled into a 4% to 4.5% range. Occupancy has also stabilised for most core CBD located offices and remains robust for well positioned shopping centres and most large-city industrial zones. Suburban and fringe commercial real estate remains more challenging. Residential values remain well bid in the major capital cities, though supply dynamics and auction clearance data suggest a softening market, most notably in Melbourne.
Investing in stock market listed REIT’s can now be done with confidence. Most REITs trade below their intrinsic underlying property values, giving investors a buffer against further devaluations. Funds from operations (mostly rent collections) are relatively stable and consistent, and balance sheets are within acceptable gearing ranges. GPT Group (one of the large, diversified REITs) is a case in point. Their net tangible assets are 15% higher than their current share price, property occupancy is 98%, and the distribution yield is over 5%.
The housing market in Australia remains in moderate undersupply, driven by long-lasting benign investment conditions, steady demand from population growth and increasing regulatory and cost pressures and constraints on development. Household indebtedness, relative to disposable income, has stopped rising, suggesting a temporary slackening of demand, ahead of a further resurgence.
There is also a strong pipeline of infrastructure development, supported by both public and private sector investment. Roads, power transmission, data centres, energy transition and railroad construction projects are abundant across the country and show little sign of abating.
Interest Rates
Australia’s Reserve Bank reduced the official cash interest rate by 0.25% to 4.1% in February. The rate cut was not a surprise as inflation had abated, unemployment ticked up a little and pockets of consumer financial stress were increasing. There is now widespread anticipation of further RBA cuts, following the pattern of some overseas central bank policy decisions. But the RBA is dogged in its inflation mitigation strategy, so did not make a cut in April, and is not communicating a clear rate reduction outlook message. Nevertheless, it’s possible that a small further 0.25% will be decided at either their May or July meeting, perhaps as a strategic confidence boost at a time of international trade and geopolitical disruption.
The yield on Australia’s commonwealth government bond is currently between 3.4% and 4.4%, depending on the security duration. The running yield is satisfactory, but not particularly appealing from an investor perspective, as other forms of low-risk investment such as cash and term deposits offer similar or better returns. Bond investors therefore need a bit more prospective return, which we think would be achieved at or above 4.5% for the local ten-year security.
APRA, the prudential regulator, has carried through with its recommendation to ban the issuance of new bank AT1 hybrid securities. This has left a hole in the retail investor marketplace which is rapidly being filled by a variety of exchange listed fixed interest, bank security and credit products, of varying quality and prospect. The big-four Australian banks have proven to offer reliable and safe investment products throughout their credit stack, so funds that package up these bank securities have some appeal.
The private credit industry has received some negative publicity, unsurprising as a plethora of higher-risk products has emerged, some of which is masquerading as private credit but often containing mezzanine and poorly secured loans of dubious quality. We think better quality private credit to be an acceptable investment and an alternate source of income for a diversified portfolio of interest-bearing securities – just do your homework and remember if the promotional return looks too good to be true, it probably is.
Looking ahead, we expect the RBA will cut the short-term cash rate at least once in the coming months, and bond yields should remain in their holding pattern as inflationary pressures have mostly abated. Hence, a rather benign outlook for the fixed interest sector. A left field risk might be a sharp sell-off in US bonds, perhaps because markets react negatively to more outlandish policy pivots, or concerns about uncontrolled deficits and the seemingly annual threats of a US debt ceiling induced shutdown. Such a scenario would precipitate a negative period for credit and equity investors.
Outlook
For the near term the outlook is highly unpredictable, due to the cascading effect of economic and geopolitical pronouncements and decisions overseas, and recently dented investor confidence. We think another few turbulent months are ahead, but probably a less disruptive second half of the year.
But for the long term the investment outlook has improved, as share and property security prices are cheaper, interest rates have stopped rising and the shallow economic cycle should turn positive.
We don’t think a full-blown trade war will erupt between the United States and China as each has a load to lose. There’ll be plenty of posturing and jawboning, probably followed by some face-saving conciliation.
Yours sincerely,
Malcolm Palmer
Joseph Palmer & Sons
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