By Grace Lagan
The ongoing tumult in geopolitics has triggered wildly different responses across markets, with Wall Street soaring even as the local bourse slumps, and oil and bond traders brace for a protracted hit from the Iran war.
After hitting a wartime low on March 30, the S&P 500 has added a staggering 16.6 per cent, equating to more than $US10 trillion ($14 trillion) in market capitalisation. That’s as a stunning earnings season – driven by further gains in technology stocks – and a robust labour market continued to overshadow fears for a protracted war in the Middle East.
Meanwhile, the S&P/ASX 200 has fallen close to 5 per cent since the start of the conflict between Iran and the United States, after three interest rate rises and poor consumer sentiment weighed on company bottom lines.
“Those markets which are characterised by having a stagflationary backdrop, including Australia, Europe and the United Kingdom, have underperformed the other markets which have higher technology exposure, such as the US, Japan and the emerging markets,” said Matt Sherwood, the head of investment strategy at Perpetual.
Fraught peace negotiations between the US and Iran – which took a blow on Monday when US President Donald Trump rejected Iran’s response to an American proposal to end the war – have exposed vast differences in sentiment across regions and asset classes.
Yields on 10-year Australian and US government bonds have risen 7.1 per cent and 11.1 per cent, respectively, since the start of the war. That’s because war-related price increases have pushed up traders’ long-term inflation forecasts, and in turn, interest rate expectations.
Traders in oil markets are also pricing in a longer-term disruption. The price on Brent crude futures contracts expiring in December – a key metric for investors trying to gauge the long-term impact of the war – rose 2 per cent over the weekend to $US89, having nearly hit $US92 last week.
While that has driven perceptions that equity traders were as a whole more bullish on an imminent end to the conflict than their peers in bond and commodities markets, Wilson Asset Management portfolio manager Damien Boey said sharemarkets were also pricing in disruption.
“Equity investors are very clearly splitting the world according to those who are terms of trade beneficiaries and terms of trade losers: that is, those that would actually benefit or be neutral from a higher oil price, and those that would outright suffer from a higher oil price,” he said.
According to Boey, the Australian economy’s dependence on consumer demand and sentiment, as well as a more hawkish monetary policy stance compared to the US, meant investors regarded it as losing out on higher oil prices. That’s despite the fact the country is a net energy exporter.
“People look at the economy and market and say, ‘you know what, there’s quite a bit of earnings risk here that I don’t necessarily need to take’,” he said.
The performance gap between US and Australian equities was also being driven by Wall Street’s heavy exposure to technology stocks, which have continued to benefit from a meteoric rise in spending on artificial intelligence hardware and data centres.
“The composition of the markets and the earnings outlook is distinctly different,” said Yarra Capital’s head of Australian equities, Dion Hershan, who said the tech exposure in the US stood in stark contrast to Australia’s concentration in resources and banks, which had a far more mixed outlook.
“We’ve also got a fair few broken blue chips, which are blowing up left, right and centre at the moment. Companies like CSL and Cochlear, with significant earnings downgrades, elevated valuations, and that’s putting downward pressure on our market,” he added.
Complicating matters for investors, according to Perpetual’s Sherwood, was the fact that local bond and equity markets were moving in tandem on higher inflation, which made it difficult for traders to hedge their positions.
That was because inflation was causing bond yields to rise at the same time stocks were insulating earnings by passing on price increases.
“If the market begins to feel that the situation around the Strait of Hormuz won’t be resolved and oil prices go up, then that could put more inflationary delta into the bond market,” he said, referring to the risk that fixed income markets could become more sensitive to inflation.
Hawkish bond traders have also not appreciated the extent to which the shock was likely to deliver a pull-back in growth and cause the Reserve Bank of Australia to hold their fire on monetary policy, according to Boey.
That meant a drop in bond yields – which would trigger a bounce in equities – was yet to arrive. “If you’re the equity market investor, and your response function is to wait for what the bond market is doing in order to get more positive, the bond market is just not giving it the love,” he said.
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