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Well, that was a pleasant surprise! Against all expectations, 2023 delivered decent returns for patient investors.
Despite war in the Middle East and Ukraine, high inflation and interest rates, a cost-of-living crisis and fears of recession, shares and bonds rallied, Australian residential property keeps on keeping on, and yields on bank deposits are the best in years.
Super funds also bounced back, more than making up for their previous year’s losses.
Ratings group Chant West estimates the median growth fund gained close to 9% in calendar 2023, following the 4% decline in 2022. It’s an impressive result and, given the wall of worries the markets scaled over the course of the year, further vindication for the benefits of holding your nerve and focusing on long-term financial objectives.
What could possibly go wrong? More on that later.
As the table below shows, the good news was spread across all major asset classes. The biggest negative was oil prices, and even that’s good news for those of us still driving petrol vehicles.
Calendar year returns to 31 December (% change)
| 2022 | 2023 | |
|---|---|---|
| Shares | ||
| MSCI World Index (excl. Australia) | -19.7% | +16.2% |
| S&P 500 | -19.3% | +24.7% |
| ASX 200 | -5.5% | +7.84% |
| Interest rates/Bond yields | ||
| Cash rate | 3.1% | 4.35% |
| Australian 10-year bond yield | +2.4% | -0.08% |
| US 10-year bond yield | +2.4% | +0.04% |
| Currency | ||
| $A vs $US | -6.2% | 0.0% |
| Commodities | ||
| Iron Ore | -6.5% | +23.4% |
| Oil (Brent Crude) | +11.4% | -10.2% |
| Gold | -0.3% | +13.1% |
| Australian residential property | ||
| CoreLogic Home Value Index | -5.3% | +8.1% |
Sources: Trading Economics, CommSec, CoreLogic
The big picture
For the Australian economy, as with much of the developed world, 2023 was defined by the long shadow of rising interest rates and inflation.
Australia’s economy grew by just 2.1% in the year to September, well below inflation of 5.4%. Soaring mortgage rates, rising cost of living, falling real wages and higher taxes due to bracket creep, all took their toll on consumer spending and confidence. When adjusted for booming migration and population growth, the economy was in recession.
And yet, unemployment remains low at just 3.9%, businesses remain resilient, and recession has been avoided here and in most major economies. We are not out of the woods yet, with economic growth in the Group of seven major economies averaging 1.8% and China’s growth slowing to a relatively respectable 4.9%.
Inflation eases but not tamed
The main bugbear for investors and investment markets was and is persistently high inflation, interest rates and bond yields, although there are positive signs that the worst is behind us.
Local inflation fell from a peak of 7.8% at the end of 2022 to 5.4% in the September quarter. Yet this is still higher than the US, at 3.1%, the UK (3.9%) and the Eurozone (2.4%).
Graph: Australian inflation
In line with other central banks, the Reserve Bank of Australia (RBA) lifted rates aggressively from 0.1% in May 2022 to 4.35% in 2023. The US Federal Reserve was even more determined, jacking up its target rate to 5.5%. However, most economists expect interest rates have peaked and the next move in the US and Australia will be a rate cut. The late rally in shares and bonds certainly echoes this belief. The major concern now is that future rate cuts don’t spark an uptick in inflation and jeopardise economic recovery.
After a rollercoaster year, Australian and US 10-year government bond yields finished the year flat at 3.96% and 3.86% respectively. As yields fall, bond prices rise, which is good for bond returns.
Aggressive interest rate hikes by the US Federal Reserve pushed up the value of the US dollar against most major currencies, including the Aussie dollar, until a late rally in iron ore prices sent the local currency soaring back to where it began the year, at US68c.
Graph: Australian dollar to US dollar
Australian shares staged a late rally in 2023, with the benchmark ASX 200 Index up 8% for the year, its best annual return since 2021 and just short of its record high. When dividends are added, the total return from Australian shares was 12.8% (as measured by the ASX 200 Accumulation Index).
While Australian share returns put a smile on the dial of local investors, returns from global shares made them positively beam. The MSCI World Index (minus Australia) was up 16% and the US market up almost 25%.
As mentioned earlier, the main driver of this rush of blood to the head was the expectation that interest rates have peaked and the next step, in the US at least, will be a series of rate cuts in 2024.
The technology sector was the strongest contributor to returns on the local market and in the US, with advances in artificial intelligence (AI) a major theme. The US Nasdaq 100 Index, home to the top 100 technology stocks including the so-called Magnificent 7 – Apple, Microsoft, Alphabet (Google), Amazon, Meta, Tesla and Nvidia – was up a staggering 55%.
The weakest sectors on the local market were consumer staples, health and utilities, in response to high inflation, high interest rates and cost-of-living pressures.
Graph: ASX 200 Index
The Chinese market was a noteworthy exception to the positive global trend, down 3.7% as the Chinese economy struggles to shake off the legacy of lengthy COVID shutdowns, high unemployment and a weak property sector.
Iron ore prices surge
The price of Australia’s major export earner, iron ore, surged 23% in 2023 to US$142 ($205) a tonne, its highest level in 18 months.
This puts Treasurer Jim Chalmers’ 2023–24 Budget on course for a surplus, following the $13.9 billion deficit predicted in the May budget papers.
Prices for the steel-making commodity rallied as China stepped up efforts to support its property market with a third round of rate cuts. As well as being a mainstay in construction, steel is also a major component in the manufacture of electric vehicles, an increasingly important export for China.
Graph: Iron ore price (US dollars)
Elsewhere on commodity markets, gold was up 13% to US$2,063 in its first annual gain in three years. The yellow metal hit a record high within the year on expectations that central banks will start cutting interest rates. Heightened geopolitical tensions in the Middle East also played a part, as gold is traditionally viewed as a safe haven asset in times of political and economic turmoil.
Fears of an oil shock failed to eventuate, despite the ongoing conflict in Ukraine and the Middle East. The price of Brent Crude fell 10% by year’s end to US$77.
Australian residential property resilient
As it turns out, talk of the death of Australia’s residential property market this time last year was wide of the mark. Despite rising interest rates and widespread mortgage stress, national average home values jumped 8.1% in the year to December, reversing the previous year’s losses, according to CoreLogic.
As the table below shows, the price gains were not uniform or universal. Perth, Brisbane, Sydney and Adelaide led the way up, while Hobart and Darwin bucked the trend with minor falls. Melbourne and Canberra posted small gains but failed to keep pace with inflation.
Combined capital city growth was more than twice that of regional areas, reversing the COVID flight to the country. However, after monthly gains peaked in May, two more rate hikes and growing cost-of-living pressures began to bite and market momentum slowed markedly in the run-up to Christmas.
Investors benefitted from an 8.2% increase in rents over the calendar year. This was down on the 9.6% return the previous year, but more than four times the pre-COVID decade average of 2% per year. As with prices, rental returns are patchy across the country, with total returns (from rents and prices) leaping 20.7% in Perth down 3.2% in Hobart.
CoreLogic Home Value Index as at 31 December 2023
| Annual | Total return | Median value | |
|---|---|---|---|
| Sydney | 11.1% | 14.3% | $1,128,322 |
| Melbourne | 3.5% | 7.0% | $780,457 |
| Brisbane | 13.1% | 17.9% | $787,217 |
| Adelaide | 8.8% | 13.2% | $711,604 |
| Perth | 15.2% | 20.7% | $660,754 |
| Hobart | -0.8% | 3.2% | $656,947 |
| Darwin | -0.1% | 5.9% | $496,309 |
| Canberra | 0.5% | 4.5% | $843,171 |
| Combined capitals | 9.3% | 13.1% | $832,193 |
| Combined regional | 4.4% | 8.9% | $605,780 |
| National | 8.1% | 12.1% | $757,746 |
Source: CoreLogic
The road ahead
As the curtain fell on 2023, markets had already priced in lower inflation, a series of US rate cuts and a soft economic landing for 2024. Let’s hope they’re right.
If those expectations are disappointed, shares could experience a pullback.
In any case, rate cuts could be slower coming in Australia because inflation is higher here than it is in the US and Europe. At 5.4%, Australia’s inflation is still well above the RBA target range of 2–3% and the mid-year introduction of stage 3 tax cuts could be inflationary.
Households should enjoy some mortgage relief if rates fall but, until then, local investors will be keeping an eye on mortgage defaults – as borrowers deplete their savings – consumer spending and employment. On the plus side, economists expect wage growth to finally begin to outpace inflation in 2024.
China’s attempts to stimulate its economy and remove remaining trade embargos on Australian exports will also be critical for Australia’s growth prospects.
Ongoing themes for share investors are likely to include the rapid development of AI, increased awareness of the need for cybersecurity technology, and demand for lithium, an essential component in the batteries that power electric vehicles.
If bond yields have peaked as pundits believe they have, then that presents an opportunity for bond investors to lock in higher rates on longer-term securities before yields fall further.
They’re the known unknowns. A potential joker in the pack could emerge from a spate of national elections in 2024, from the UK and across Europe to India, Indonesia and the big one – the US on 5 November.
If the last few years have taught us anything, it’s to expect the unexpected. One thing we can predict with some certainty, though, is that market volatility and uncertainty are likely to persist in 2024. And that investors with a diversified portfolio tailored to their needs, who maintain a long-term focus and stay the course, are likely to weather whatever conditions come their way.
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