Information technology was the best-performing sector in May returning 8.5%, as some of its constituents (and some of the biggest companies out there) like Nvidia, Microsoft and Apple posted positive returns. This move is, among other things, based on the continuous focus on AI and other tech-related industries. Utilities and communication services also posted strong returns of more than 6%, while energy and consumer discretionary were the worst performers, closing out basically flat for the month.

 

The ride for shares is likely to remain volatile and constrained as valuations remain stretched, sentiment towards shares remains upbeat (negative from a contrarian perspective), uncertainty remains regarding the outlook for interest rate cuts in the US and Australia and geopolitical risks around the Israel/Iran conflict and US election are high. We continue to see further gains in shares this year as disinflation continues, central banks ultimately cut interest rates and a recession is avoided or proves mild. However, the risks of a deeper correction beyond that seen in April have increased.

 

Australian inflation surprisingly rose in April. The uptick in the Monthly Inflation Indicator to 3.6% YoY from 3.5% YoY was disappointing. The main drivers were weather related food prices, tobacco, health insurance premiums, fuel prices and continued rapid increases in rents and general insurance. Worryingly for the RBA, underlying measures of inflation edged higher with the trimmed mean inflation rate rising to 4.1% with ongoing sticky services inflation. The further uptick in inflation keeps the risk of another RBA rate hike high and reinforces that rates will be high for longer. This was reflected in money market expectations that swung back towards pricing in the risk of another rate hike and pushed back expectations for a rate cut until late next year. Inflation is likely to resume its downtrend and the economy is looking weaker, so we still see the next RBA move as being a cut. The RBA is likely to again consider the case for another rate hike at its 18 June meeting just like it did at its May meeting. However, while the risk of another hike is high (particularly in August if June quarter inflation is higher than the RBA expects) the most likely scenario is that rates will remain on hold.

 

There was more mixed US economic data during the month. The Conference Board’s measure of consumer confidence improved in May and the net proportion of respondents reporting that jobs are plentiful improved slightly. The trend remains down in the latter, home price growth slowed in March, March quarter GDP growth was revised down to 1.3% annualised from 1.6%, with downward revisions to wages growth and core inflation, as well as personal income and spending being weak in April, with real spending down 0.1% MoM. Core services ex housing inflation also trended lower. This is good news for the Fed, but it will probably need to see three months of core PCE inflation around 0.2% MoM before starting to cut. We continue to see the first Fed cut being in September.

 

Easing inflation pressures, central banks moving to cut rates and prospects for stronger growth in 2025 should make for reasonable investment returns this year. However, with a high risk of recession, delays to rate cuts and significant geopolitical risks, the remainder of the year is likely to be rougher and more constrained than the first three months were.

 

Bonds are likely to provide returns around running yield or a bit more, as inflation slows, and central banks cut rates. Unlisted commercial property returns are likely to be negative again due to the lagged impact of high bond yields & working from home. Australian home prices are likely to see more constrained gains this year as the supply shortfall remains, but still high interest rates constrain demand and unemployment rises. The delay in rate cuts and talk of rate hikes risks renewed falls in property prices as it’s likely to cause buyers to hold back and distressed listings to rise. Cash and bank deposits are expected to provide returns of over 4%, reflecting the back-up in interest rates.