In this month’s update, we provide a snapshot of economic occurrences both nationally and from around the globe.
– Central banks close to contractionary interest rate policies – the US raised 0.75% in early November
– Reserve Bank of Australia moves cautiously again raising rates by 0.25% to 2.85% on Cup Day.
– US earnings season contains some surprises positive (banks) negative (big Tech)
– Share markets have a positive month in some cases recovering all of Septembers losses
We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact our team.
The Big Picture
The ASX 200 and the S&P 500 both had stellar months in October. However, September for both of those indexes had been very bad. Does this cancellation of much of the September woes mean that a bottom has been reached and the next rally has begun? We think it is too early to draw that conclusion – but it is possible.
Markets at the end of bull and bear markets often display amplified volatility but, this time, there is more information about future conditions than usual. The dominant feature so far of 2022 has been the possible success or otherwise of central banks’ ability to control inflation without causing a recession.
The US and Australian economies are currently far too strong to think about imminent recessions but the UK and Europe certainly have deep-seated problems. China, largely because of an insistence on a zero-Covid policy, has found itself with slower growth than in recent times but it is self-induced and could easily be reversed if China wants.
Monetary policy was never designed to control many of the current sources of inflation: the Russian invasion with consequent food and energy price inflation; and covid-induced supply chain issues such as the current chip shortage for cars and so many other modern technologies.
The strength of labour markets suggests that some ‘demand induced’ inflation exists in various countries and that variant might respond to interest rate hikes.
Because rates were so low – zero or negative in many cases – the recent sharp increases in rates have only taken rates up to what is often referred to as the neutral rate – the rate that divides expansionary from contractionary policies. We think no major Western economy has yet crossed that line in any material way. However, continued hikes at the recent pace could take some economies into significant slowdowns and possibly recessions. We will know a lot more by the end of this year.
The IMF and some noted fund managers have started to talk about a possible recession in the US but not necessarily in Australia. Based on what we currently know we would largely agree with that assessment.
The Reserve Bank of Australia (RBA) has been far less aggressive in its policy stance than the US Federal Reserve (Fed) who again increased their cash rate by 0.75% on 3 November accompanied by a statement that easing off the pace of policy tightening was not supported by recent data. In both countries, a slowdown and pullback in house prices are well underway. While house prices were getting out of hand, a pronounced downturn in house prices would reduce perceived and actual household wealth. Such a loss of household wealth could accelerate and deepen any recession.
If central banks deftly avoid recessions, markets may well have already bottomed and the next big rally could get underway. If central banks push interest rates too far, a second market downturn could easily start.
However, the S&P 500 is about 20% below its 2022 peak; the ASX 200 is about 10% below its peak. There is plenty of room for upside if and when the dust settles after the volatility created by central bank policy tightening subsides. Despite equity markets having corrected this year prudent investors wouldn’t just ‘pile in’ now as it would be a big gamble in the short run.
The US third quarter company earnings reporting season is well underway. While there have been a number of really good results, there have been some notable underperformers – particularly among the big tech companies. Microsoft, Apple, Amazon, Meta (formerly Facebook) and Alphabet (formerly Google) amongst others lost significant company value on their announcements. Do these falls make them good buying opportunities? Maybe – but they could have just been too expensive before.
Some are asking if we are in a repeat of the dotcom boom and bust over 20 years ago. We would say no. All of these big tech companies currently experiencing downturns are well established with revenue streams. The dotcom boom was about ideas and hopes for future revenue. Many of those ideas just didn’t cut the mustard.
The era of ‘cheap money’ is over for now. Investors must now weigh up alternatives. 10-year government bonds in the US and Australia have come from very low values to yields fluctuating around 4%. Equities, while not as attractive relative to bonds as they once were, more selectively still present opportunity. Getting the asset allocation right for the next while is important, as appropriate diversification is a proven way of assisting to mitigate investment risks in uncertain times.
Of course, lurking in the background is the impact of the ongoing Russian invasion of the Ukraine. Few, if any, are sufficiently skilled to predict outcomes on that basis. It does seem that the Ukraine is now holding its own and Russia has not had the success it must have expected. Maybe that is why they just stopped the grain shipments again!
Europe and the UK are heading for a dismal (northern) winter. Energy prices are out of control and recessions seem inevitable if, indeed, they haven’t already started.
Our economy is doing well and Jim Chalmers just delivered a sensible, if not boring, budget. The RBA seems to be in control and China is not doing as badly as some predicted. We in Australia can escape a recession but growth might well be sluggish for a while. Markets typically focus on expectations rather than actual current conditions – so markets could turn up before economic data confirm that the worst is behind us.
The ASX 200 had a positive month rising 6.0% but that gain was on the back of a 7% loss in September. Most sectors did well in October though Materials, Staples, Health and Telcos performed poorly.
While we believed the ASX 200 was attractively valued a month ago, much of that mispricing has been erased by recent gains. While Refinitiv forecasts of company earnings are softer than earlier in the year, there is some optimism for capital gains over the next year in addition to possibly eroding the remaining perceived over-pricing. Expected dividend yields, grossed up for franking credits, are around 6%.
The S&P 500 gained 8.0% in October almost offsetting the 9.3% loss in September. The World index was up 7.7% in October but Emerging Markets lost 3.1%.
The Dow Jones had its best month since 1976!
Many of the big international banks did particularly well in the current reporting season but Credit Suisse took a big hit. By and large big tech stocks did not fare well.