As the financial year came to a close, markets were marked by significant volatility and diverse returns, presenting new opportunities for asset allocators amid rapidly changing conditions. Here, we delve into the recent share market performance, key influences, and what this means for Australian investors.

Interest Rate Movements and Inflation Concerns

The last week of June 2024 saw a sharp increase in interest rates, particularly at the longer end of the yield curve. This rise was predominantly driven by renewed inflation concerns in several countries, including Australia and Canada, where inflation figures came in higher than expected. These developments led markets to speculate that central banks, including the Reserve Bank of Australia (RBA), might need to implement further rate hikes within the year to manage inflation.

In the United States, the PCE inflation measure, which is closely monitored by the Federal Reserve, showed a slight decrease, offering a glimmer of hope. However, the market was unsettled by the first presidential debate between Donald Trump and Joe Biden. Trump’s strong performance raised the possibility of a return to populist policies, such as lower taxes, higher fiscal deficits, and increased government spending. This uncertainty caused the 10-year U.S. Treasury yield to spike to 4.5%, reflecting market concerns about future economic policies.

Overview of Market Performance

The performance of markets throughout the financial year was largely influenced by interest rate movements, with significant fluctuations observed in the latter part of the year. Interest rates trended higher during the first two quarters before some market instability in late 2023 brought them down. This dynamic of disinflation, where inflation rates decrease but remain positive, fueled substantial gains in tech and growth stocks in early 2024.

• Nasdaq: The Nasdaq index surged by 30%, led by strong performance from semiconductor stocks like NVIDIA. This sector benefited from robust demand and technological advancements, driving significant investor interest.

• Software Sector: While the broader tech sector saw gains, the software segment slightly underperformed. Investors seemed more cautious about software stocks, possibly due to concerns over valuation and future growth potential.

• Cyclicals and Value Stocks: Cyclical stocks, which are sensitive to economic cycles, and value stocks, which are considered undervalued compared to their fundamentals, lagged behind. Global small caps, emerging markets, Australia, and the UK saw modest gains of 5-10%.

• European Markets: European markets landed somewhere in the middle, achieving mid-teen returns. The region's economic recovery, coupled with supportive fiscal policies, contributed to these positive results.

Performance of Diversified and Industry Super Funds

For diversified funds, a typical 70/30 growth allocation yielded gains around 10%. Passive funds, which replicate the performance of a market index, potentially outperformed due to their higher exposure to mega-cap U.S. tech stocks. In contrast, active managers, who select specific investments to outperform the market, appeared to lean away from this trend despite the gains. Industry super funds, which generally maintain more aggressive 80/20 "balanced" allocations, faced challenges over the past 18 months. Higher interest rates pressured the valuations of their private asset holdings, making it a difficult period for these funds.

Global Equities: Growth vs. Value

In the realm of global equities, growth and value stocks performed similarly overall, marking a shift from value's multi-year run of outperformance. However, there were significant divergences based on sector and regional allocations:

• Growth Stocks: Within the growth category, semiconductor-heavy growth funds surged over 40%, driven by technological advancements and strong demand. On the other hand, software-focused funds saw more modest gains of around 10%, with some remaining flat, as observed with hyper-growth focused funds.

• Value Stocks: Value funds had mixed performance. Financial sector exposure boosted returns for some value funds, but many lagged behind the broader market. This was especially true when "value" included emerging markets or smaller companies, resulting in returns between 5% and 15%.

Bond Market Performance

The bond market also experienced significant dispersion in returns:

• High Yield Credit: High yield credit, or junk bonds, gained around 8%. However, these returns came with much higher volatility compared to other fixed-income investments.

• Investment Grade Floating Rate Funds: These funds, which invest in high-quality bonds with interest rates that adjust periodically, returned similar amounts to high yield credit but with less volatility.

• Government Bonds: Government bonds rose 2-3%, with volatility levels of 5-6%. These investments are generally considered safer but provided lower returns.

• Australian Floating Rate Corporate Bond Funds: These funds emerged as standout winners, gaining 6-8% with minimal volatility. Their performance was bolstered by the rising interest rate environment, which benefits floating rate instruments.

Implications for Australian Investors

The end of the financial year highlighted sharp divergences across and within asset classes, presenting both challenges and opportunities for Australian investors. Here are a few key takeaways:

1. Interest Rate Sensitivity: With interest rates rising, investors should be mindful of the sensitivity of their investments to rate changes. Fixed-income investments, especially those with longer durations, may face headwinds in a rising rate environment.

2. Diversification: Diversified investment strategies, which spread risk across various asset classes and regions, can help manage volatility and capture opportunities in different market conditions. Investors should consider maintaining a balanced portfolio to navigate the uncertain landscape.

3. Growth vs. Value: The performance gap between growth and value stocks highlights the importance of sector and regional allocations. Investors should evaluate their exposure to different sectors and regions, ensuring alignment with their risk tolerance and investment objectives.

4. Active vs. Passive Management: The mixed performance of active managers versus passive funds underscores the need for careful selection. While passive funds may provide broad market exposure at lower costs, active managers can add value through selective investment strategies, particularly in volatile markets.

5. Superannuation Considerations: For those invested in industry super funds, understanding the impact of interest rates on private asset valuations is crucial. Investors should stay informed about their fund's allocation and performance, and consider consulting with financial advisors to optimise their superannuation strategy.

The financial year ended on a turbulent note, characterised by significant volatility and diverse returns across asset classes. As markets continue to navigate interest rate movements, inflation concerns, and political uncertainties, Australian investors must stay vigilant and adaptable. By maintaining a diversified portfolio, staying informed about market developments, and aligning investment strategies with long-term goals, investors can effectively manage risks and seize opportunities in an ever-changing market environment.