ASX 200 Hits Record High in July: Key Drivers and Sector Performance
The ASX 200 surged by 4.2% in July, reaching a new peak for the equity market index. This impressive rise was fueled by a favorable inflation report in Australia and expectations that the US Federal Reserve might cut interest rates in September. These factors sparked significant gains in cyclically exposed industries, with Discretionary Retail (+12.2%), Banks (+7.1%), and Real Estate (+6.6%) leading the charge.
Banking Sector Shines
Australian banks made the most substantial contribution to the market's return, given their significant weight of approximately 22% in the ASX benchmark. From the market lows in October 2023, banks have accounted for 40% of the benchmark's return. This strong performance has pushed bank valuations to record levels, with 1-year forward Price Earnings (P/E) multiples trading at around 18 times. The major banks' returns have been bolstered by a resilient economy, disciplined lending standards, and robust regulatory capital positions, which have supported share buybacks. However, we believe that the re-rating of banks is now overdone, as current valuations are significantly above long-term averages, and the outlook for earnings growth is uninspiring.
Resources Sector Struggles
In stark contrast, the Resources sector has underperformed due to weakening commodity prices, driven by the strong US dollar and challenges in the Chinese economy. The Chinese property sector's oversupply issues and financial de-leveraging have created ongoing headwinds.
Market Valuation Concerns
Price momentum, rather than profit momentum, has driven the ASX 200 to record levels in July. The re-rating of the ASX 200, primarily driven by banks, has pushed the market P/E to a 1-year forward P/E of 17 times, well above its long-term average of around 14 times. Overall earnings growth for the ASX 200 appears lackluster, with a forecasted decline of approximately 4% for the upcoming FY24 reporting period. Given the growing evidence of elevated valuations and consistent signs of slowing economic activity, we reduced the portfolio's exposure to economically sensitive sectors in June 2024 and increased the weighting to defensive stocks, particularly utilities.
A Cautious Outlook
As we highlighted in our last monthly update, we believe a more cautious stance on equity markets is warranted. We are entering a period of heightened earnings uncertainty, with interest rates remaining elevated, particularly in Australia, and government debt levels being burdensomely high.
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