By Andrew Marchant, Minchin Moore Chief Investment Officer (CIO) & Partner, with thanks to Dr Steve Garth, Industry Veteran, Minchin Moore Investment Committee Member.

Contents

• In a Nutshell
• Major Themes
• Markets at-a-Glance
• News Highlights
• Financial Markets Overview
• Portfolio Performance
• Portfolio Strategy: Introducing an Innovative Approach to Debt Investing

In a Nutshell

Global share markets hit record highs in 2024, despite geopolitical tensions, electoral upheaval and economic challenges. The US market, led by tech names, was the standout. Australian stocks rose more modestly, led by banks and offset by resources. Bond yields fell as central banks began cutting rates but rose again as Trump’s return boosted inflation fears and markets pared back expectations for further interest rate cuts by the Federal Reserve. The US dollar posted its strongest gains in a decade, while commodities were mixed.

Major Themes

If ever there were a year to highlight the dangers of using political and economic developments as a pointer to where and when to invest, 2024 was the one.

As the year began, pundits pointed to stubbornly high inflation, interest rate uncertainty, wars in Ukraine and the Middle East, and the prospect of potentially destabilising elections in more than 60 countries – most notably in the US – as reasons to be cautious.

Yet the year ended with robust results for equity markets, including double-digit gains in the US, Australia, Japan, and China and single-digit returns in the UK and much of Europe. A shift to lower interest rates outside Australia boosted sentiment from September.

Record highs were set in 2024 by equity benchmarks in the US, Japan, Europe and Australia. Massive gains in technology leaders like Nvidia powered the S&P 500 25% higher over the year. Financials were also strong, but energy and materials lagged.

US equity market gains accelerated sharply after Donald Trump’s clear election win in November, aided by hopes of further tax cuts and deregulation.

However, the stock market euphoria was offset by caution in the bond market, where long-term yields reversed the falls of earlier in the year on expectations the second Trump presidency’s anti-immigration, pro-tariff policies would restoke inflation.

With the market rethinking the pace of US rate cuts in 2025, the US dollar registered its strongest yearly advance in nearly a decade. Gold also posted its best year since 2010. Oil and iron ore prices, however, weakened as the Chinese economy struggled.

Markets at a Glance

News Highlights

October

• Queensland LNP defeats ALP in state election, ending nine years of Labor rule
• ECB lowers benchmark interest rate to 3.25% in third easing in 2024
• Spread between investment grade debt and US Treasuries falls to 20-year low
• Israel kills Hamas leader; launches attack on Hezbollah in Lebanon
• Israeli warplanes target Iran’s defence systems in reprisal for Iranian missile attack
• Japanese election: Ruling LDP loses parliamentary majority for first time since 2009

November

• Donald Trump wins 2024 US presidential election in historic comeback
• Republicans win control of US Senate; retain narrow majority in House of Reps
• Markets, led by Tesla and Bitcoin, surge amid hopes of tax cuts, deregulation
• UN climate summit agrees on $300bn funding deal for developing nations
• ICC issues arrest warrant for Israeli Prime Minister Benjamin Netanyahu
• Fighting ends in Lebanon as Israel and Hezbollah agree on 60-day ceasefire

December

• Bitcoin storms above $US100,000 as Trump 2.0 fuels crypto euphoria
• South Korea in crisis as President Yoon issues, then rescinds, martial law decree
• French parliament votes out centrist government led by Michel Barnier
• German government of Olaf Scholz collapses; paving way for early 2025 election
• Syrian rebels topple dictator Assad who flees to Russia in Middle East shake-up
• US Fed cuts rates for third consecutive time; points to fewer reductions in 2025

Financial Markets Overview

Equity markets powered to record highs in 2024, overcoming expectations earlier in the year that sentiment would be derailed by geopolitical and economic uncertainty, as well as elections in more than 60 nations, including the US, the UK, India and Japan.

Most attention focused on the US presidential election, amid fears that another contested result, as in 2020, might spark instability. As it was, Donald Trump was re-elected to another term, winning both the Electoral College and the popular vote. The Republicans also secured majorities in both houses of Congress.

The US equity market had already been rallying through the year on the prospect of interest rate relief by the Federal Reserve, which began cutting rates in September. But gains accelerated after the Trump win in early November – in part due to the clear result and in part due to expectations of further tax cuts and deregulation.

While the Fed, at its final meeting for the year, cut interest rates by another quarter percentage point as expected, its tempering of expectations for further rate cuts in 2025 put the brakes on the equity market rally. Between Christmas and New Year, the S&P 500 fell by 2.6% while the tech heavy Nasdaq index fell by 3.5%.

The US S&P 500 still ended 25% higher over the year, bringing its gains to more than 50% since the start of 2023. This is its best two-year performance since the ‘dotcom’ euphoria of the late 1990s. In 2024, the artificial intelligence boom again was a major driver of US stocks, with heavyweight Nvidia up a stunning 170%.

While equity markets cheered Trump’s victory, the bond market was more cautious. Longer-term yields reversed course to give up most of their gains for the year on expectations the new administration’s anti-immigration, pro-tariff policies would boost inflation.

Outside the US, many other equity markets also hit record highs. Japan’s Nikkei overcame a major stumble in August, sparked by a surprise rate hike, to end the year up nearly 20%. China’s Shanghai composite bounced back from three years of losses to end 13% higher as new government stimulus measures offset ongoing weakness in China’s property sector.

In Europe, equity market gains were more modest as uncertainties over the Trump administration’s tariff policies and war in Ukraine weighed on sentiment. The pan-European Stoxx-600 index rose just 6% in 2024 after a negative fourth quarter.

In Australia, the S&P/ASX 200 index rose around 11% in 2024, similar to the previous year, but this masked a mixed sectoral picture, with strong rallies in the major banks offset by weakness in materials and energy stocks.

The Australian economy struggled through the year. According to the national accounts, GDP grew by just 0.8% in the year to September. On a per capita basis, which adjusts for immigration, the economy shrank for seven consecutive quarters.

Despite this, the Reserve Bank of Australia was one of the few central banks not to cut interest rates in 2024. Its December board minutes showed members believed underlying inflation was still too high, although markets were pricing a rate cut for early 2025.

The Australian dollar ended the year below 62 US cents and down from 68 cents the year before, the victim of the weak domestic economy, concerns over China’s outlook and a broadly stronger US dollar. The greenback’s 8% annual gain, powered by the relative resilience of the US economy, was its best one-year performance since 2015.

Among commodities, expectations of weaker Chinese steel output weighed on prices for iron ore, one of Australia’s major exports. Oil prices fell about 3% over the year, pressured by both demand and supply concerns. Brent crude finished the year around $US74 a barrel. Gold, however, soared 27% in its biggest annual gain in 14 years.

Looking to 2025, markets are weighing the impact of the incoming Trump administration’s economic and geopolitical policies, particularly in relation to trade, immigration, Ukraine and the Middle East. Also in focus is China’s likely response to Trump’s threatened tariff increases and Beijing’s own success in stabilising its economy.

In Australia, eyes will be on the RBA’s first board meeting of the year in February. Also in focus locally is the upcoming federal election, which the Albanese government must hold by May 17. Current opinion polling is pointing to the possibility of a hung parliament.

Portfolio Performance

Global share markets hit record highs in 2024, and for the most part the rally continued into the last quarter, although faltered in the final weeks of the year. The return for most of the growth asset classes for the quarter was between -1% and +2% although unhedged International Shares benefitted from a 10% decline in the Australian dollar. Annual returns for growth assets were all above long-term averages.

In equities, developed international markets delivered returns well above 20% for the year. The US Tech sector (Information Technology and Communications) posted exceptional 12-month returns as the large Nasdaq stocks continued to benefit from enthusiasm for AI. Of the other large sectors that dictate overall US market performance, banks did well but this was offset by the poor performance of healthcare stocks. Consumer Discretionary stocks remained strong performers.

The Australian share market overall posted a solid 12-month return of 11%, while Property & Infrastructure gained 14%.

It is important to understand that ‘the market’ is more than the index. Within Australian shares, for instance, we can combine three broad components (or ‘factors’) to construct a well-diversified aggregate portfolio:

• Large companies (for broad market exposure),
• Value companies (those with cheaper relative valuations), and
• Mid/Small/Micro-Cap companies (those expected to deliver higher returns over time).

The evidence shows that each of these components behaves differently through time, and each plays its own role in performance and risk management. Through the investment cycle, we expect each to experience a different sequence of return. This opens opportunities for investors to top up the underperforming components and take profits from the components that are performing well.

The Australian market is clearly top-heavy, with banks and miners representing more than 50% of the index. We seek to manage risk and improve diversification in large caps by allocating equally across the industry sectors, rather than adopting the traditional market-weighted approach. This takes advantage of the less-than-perfect correlation between sectors, which can be seen clearly in the table below.

The top and bottom two sectors for each quarter of the previous year have been highlighted, the top ones in green and the bottom in red. You can see that the annual returns to December 2024 ranged from -14% for Energy and Materials to +50% for Information Technology (which rode on the tailwinds of US tech momentum) and a remarkable +34% from Financials, driven by the big four banks.

Materials were hampered by the poor performance of the Resource sector, which is tied to China’s slowing economy. Iron ore prices tumbled by more than 23% in 2024, mainly due to concerns about weak demand from China’s sluggish construction sector. Consequently Australia’s big mining stocks posted double-digit negative returns.

Despite the largest Industry Sector (Financials) dominating the S&P/ASX 200 Index return for the year, our more broad-based Industry Equal Weight strategy still managed to post a higher return. While our equally weighted approach has relatively less invested in financials stocks than the market index, it has greater exposure to other, smaller sectors such as technology and consumer discretionary (both of which performed well).  Notably, larger-than-index holdings in Aristocrat (+70%), WiseTech (+61%), Xero (+50%), and Brambles (+46%) helped drive stronger-than-market returns for the Industry Equal Weight strategy overall.

Sustainability-focused portfolios, which don’t have exposure to the fossil fuel-heavy Energy and Utilities sectors, enjoyed even higher returns thanks to larger weightings to sectors such as IT, Financials, and Consumer Discretionary. Over the longer term we still expect returns from each approach will be similar given the consistent underlying investment philosophy, but this again highlights the virtue of diversification as Industry Sector returns can vary widely in a 12-month period.

Within defensive assets, Australian debt (hybrid securities) posted the best annual return in a decade (+5.7% or 8.1% including franking credits) as did cash (+4.5%). Both asset classes benefit from higher interest rates, and hybrids additionally from tighter credit spreads.

The quarterly return was negative for International debt (-1.2%) as financial markets adjusted expectations for the future path for monetary policy, pushing longer dated bond yields higher.

The US yield curve is no longer “inverted”, as 2-year yields ended lower than 10-year yields, the usual definition of a “normal” yield curve. Short-end yields fell as traders priced in the interest rate cuts that started in September, while longer-term yields started rising again on expectations about inflation and where interest rates will end up longer term.

For diversified portfolios, performance for the December quarter ranged from +1% for 50/50 growth/defensive allocations to +2% for 85/15 portfolios.

Annual returns for diversified portfolios to the end of December 2024 ranged from +9% for 50/50 portfolios to +14% for 85/15 portfolios.

In summary, despite a subdued December quarter, investors have enjoyed consecutive years of returns higher than long-term averages. Spreading exposure across sectors, countries and asset classes paid off, highlighting the benefit of a systematic and diversified investment strategy.

While uncertainties over economic growth, inflation, interest rates and geopolitics continue to beset investors heading into calendar 2025, the evidence-based and disciplined approach embraced by Minchin Moore remains the best protection against the unexpected.

Portfolio Strategy: Introducing an Innovative Approach to Debt Investing

Overview

Minchin Moore is always looking for ways to fine-tune our investment approach, with an eye to improving the reliability of outcomes for clients, while maintaining flexibility, increasing transparency and lowering costs.

It is in that context we are excited to announce several innovations in our approach to investing in the defensive portion of your portfolio (i.e. the lower risk part of the portfolio that includes cash, government bonds and credit securities).

Where in the past our approach relied on using aggregated bond and credit funds to obtain a wide-ranging exposure to fixed interest markets, going forward we will be more targeted in our allocations to sub-categories of these markets – for instance we will more deliberately control allocations to safer government securities, versus more volatile corporate securities.

This change will see us invest directly in Australian Commonwealth Government bonds for the first time.

The new approach will allow us to have more control over the risks and expected returns in the portfolio, and we will be better placed to match specific investment objectives to client needs.

The Background

In recent years, pooled bond funds – whether traditional index vehicles or those that use differently optimised rules – have produced mixed and sometimes disappointing results, alongside some challenges related to currency hedging and fund accounting that have affected distributions.

We have undertaken a full review of our approach to debt portfolio construction and determined that making more deliberate allocations to investments that achieve the objectives clients are seeking would be both more effective and efficient.

Debt investments play several roles in a diversified portfolio: they provide defence against equity market downturns, generate reliable income, and provide liquidity for rebalancing and cashflow requirements.

The innovations we are making will allow us to better target those three main aims, while providing more design flexibility, lowering costs, enabling targeted and controlled exposure, boosting transparency and aiding systematic rebalancing.

The Changes in Detail

Among the innovations, we will invest directly in Australian government bonds for most portfolios rather than through a managed fund, to both increase control and reduce cost.

After our efforts to bring down costs in other asset classes, debt investments are now a relatively expensive part of portfolios. Given the lower expected returns from defensive assets relative to growth assets we were determined to save every possible basis point so clients could achieve the maximum share of returns generated.

We will also now allocate your investments to match the three core roles of fixed interest assets, providing: 1. defence, 2. liquidity and 3. income.

Whereas before we broke Debt into two components being ‘Australian Debt’ and ‘International Debt’; going forward we will label the components by their fundamental nature rather than according to geography. Debt investments will be classified as either ‘Government Bonds’ or ‘Credit’ (i.e. corporate debt securities).

The reason for this change is that the characteristics of bonds vary greatly in terms of issuer credit quality, term to maturity, coupon level, and interest type (fixed or floating). This can result in quite different behaviour depending on market conditions and macroeconomic drivers.

While they are convenient, bundled bond investments also combine both higher yield securities (e.g. less defensive corporate bonds) with more defensive securities (e.g. lower yielding government-issued bonds) in mixes that evolve with issuance.

This can create some challenges. For instance, in an equity downturn government bonds are often more sought after, while corporate bonds can be less likely to increase in value. Holding these different types of bonds together in a pooled fund can therefore mute the defensive role of the asset class.

Investing in an index also means you lose control of composition. The mix of government and corporate bonds on issue changes over time, as does the interest rate duration of the index. It may be more effective to adopt an approach that seeks to control these important characteristics more deliberately.

Buying bonds in ‘components’ not bundled together in a pool can generate fee savings and rebalancing opportunities as each component is driven by different dynamics across the investment cycle.

The Benefits to You

Minchin Moore’s innovations in its approach to debt portfolio construction will provide a number of tangible benefits to clients.

Firstly, the changes will cut the management expense ratio for debt investments by up to 75%.

Secondly, taking a disaggregated approach will allow us to control exposure to key factors including exposure to government bonds and credit, geography, and duration.

Thirdly, the changes will generate more design flexibility, enabling us to better balance the sometimes-competing objectives of liquidity provision, income generation and ensuring a defensive cushion in an equity downturn.

Fourthly, shifting to direct investing and more domestic investing will provide a closer connection to income and more reliable cashflows.

Fifthly, the changes overall will allow for more effective and efficient rebalancing of portfolios, while achieving greater transparency.

Finally, all this can be achieved without taking on any additional risk in terms of term or credit quality, and without sacrificing yield.

We welcome any questions you have around these changes and look forward to talking to you about them in more detail at your next review meeting.