Insights

When Sector Concentration Stings

The sector concentrations that had shielded the Australian market from the worst of the global equity market route stings investors in June. Australia’s 2 biggest sectors now face increasing headwinds.



The Australian equity market had been one of the best performing markets this year but has been tested in June. Figure 1 below provides a return comparison between the S&P/ ASX 300 Index and the MSCI World Index YTD to the end of May. The S&P/ASX 300 index was only down -1.6% while the MSCI World Index (AUD) was down -11.8%.1 The biggest driver of this outcome was the different index weights.

Figure 1, below highlights the two biggest sectors in the S&P/ASX 300 Index, financials with a weight of +28.3%, and materials with a weight of +24.3%. The financials sector was up +2.1% and the materials sector was up +10.3%. In other words more than 50% of the index was able to generate positive returns and this reduced the losses for the index. In contrast the MSCI World Index has a 22.1% weight to Technology which was down -20.9% YTD to the end of May. In Australia the technology sector was down even more -26.3% but had a much smaller impact on the total index as it only made up 3.6% of the index. In June the S&P/ASX 300’s concentrated weight to financial and materials hurt performance.

Figure 1: Returns Comparison - S&P/ASX 300 Index vs MSCI World Index (YTD to 31 May 2022)

Source: Factset, SSGA, as at 31 May 2022. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income as applicable.

In June the S&P/ASX 300 Index was down -9.7% with financials down -12.3% and materials down -13.1%. Technology stocks were also down -26.3% but hardly impacted total performance.

Figure 2: Returns Comparison - S&P/ASX 300 Index vs MSCI World Index (MTD to 23 June 2022)

Source: Factset, SSGA, as at 23 June 2022. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income as applicable.

From December 2015 to December 2021 we have seen a positive relationship between the financial companies relative performance and changing expectations of interest rates. From December 2015 to September 2020 falling rate expectations were associated with underperformance of the financials. The banking sector typically experiences lower net interest margins (NIM) when short term rates decline. From September 2020 to December 2021 with improving economic sentiment and growing expectations of rising short term rates financials outperformed. In June this relationship decoupled. Why might this have happened?

Figure 3: Relative Performance of the Financials excluding REITS and the Australian 2 Year Bond Yield

Source: Factset, SSGA, as at 24 June 2022. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. This information should not be considered a recommendation to invest in a particular sector or to buy or sell any security shown. It is not known whether the sectors or securities shown will be profitable in the future.

In 2022 as inflation surprised on the upside and the Reserve Bank of Australia (RBA) raised rates by 75bps, and the market factored in even further tightening, investors became concerned about the risk to Australian growth. With rates moving higher there is now a greater risk of an economic slowdown, a softer housing market and lower loan growth, all of which has negative implications for the profitability of many financial companies especially the banks. With many financials still ranking as relatively expensive2 the financials may be less resilient.

The materials sector is also looking less resilient as risks of softening global growth increase. Economic theory suggests slowing global growth is usually associated with lower demand for many commodities, lower commodity prices and commodity related companies underperforming. Empirical analysis supports this theory with periods of softening growth expectations (proxied by a flattening US yield curve) being associated with the global materials sector underperforming.

The Bottom Line

The S&P/ASX 300 Index had an incredibly resilient start to 2022 with both materials and financials helping cushion our local S&P/ASX 300 index. In June expectations for both global and domestic growth deteriorated. The index concentration that helped the Australian market to the end of May hurt investors in June as both Materials and Financials underperformed. A reminder of the risks of an overly concentrated portfolio or index.


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