More Shocks?

May 2022 Monthly CiN-sights

Global equity markets struggled again in April, following on from a volatile March quarter where a number of macro shocks impacted investor sentiment. These shocks of geopolitical events, commodity/energy price spikes, surging inflation and the resultant interest rate response, health fears with ongoing Covid lockdowns in China (impact on supply-chains) and the cost-of-living pressures, saw all major US indices fall. The Nasdaq Composite index recorded its worst month since 2008, falling 13.3% and the S&P500 declined 8.8%. The ASX200 recovered from its low point of -3.3% intra-month to end down only 0.86%.

Domestically, the Government released their 2022/23 Federal Budget which not surprisingly saw a major focus on the current cost of living challenges with a number of fiscal stimulus measures announced. A halving of the fuel excise (22.1c per litre) for 6 months, an extra $420 tax offset for low and middle income earners and a $250 one-off cash payment for eligible social security recipients were the key items for households. More broadly, the focus on infrastructure spending continued with an additional $17.9bil concentrated on roads and rail plus a new home guarantee scheme worth $8.6bil.

With the Prime Minister, Scott Morrison subsequently calling a General Election for May 21st, this will be an interesting time for the ASX as inflation tensions have continued to pressure the RBA to respond to these pricing issues with interest rate hikes. The March quarter CPI release saw YoY headline inflation at 5.1% and core at 3.7%, the highest levels since 2001 and 2009 respectively. With the core CPI number now sitting above the RBA’s 2 to 3% target range, a number of economists forecast a rise in their May 3rd meeting, which would be the first hike since November 2010. The tone in the RBA April meeting was more hawkish as they acknowledged inflation will lift over coming quarters and they have removed their wording of being “patient” with rates.

Australia CPI, Trimmed Mean and Weighted Median, Annual Movement,%

In the US, the Federal Reserve has raised rates for the first time since 2018 as inflation spiked. The latest March headline inflation number rose to its highest YoY level of 8.5% since December 1981, albeit the core monthly number which excludes the volatile food and energy components was a slight beat on expectations. The previous optimistic narrative of “transitory inflation” is gone and with the current elevated CPI levels impacting household finances, economists are now asking can the FED actually manage to deliver a soft landing for the economy. Even with wages growth running at circa 5.5%, pay checks are being eroded with the elevated inflation reading and highlights the risk to consumer spending. The market consensus is rate hikes at each of the remaining six FOMC meetings in 2022, with the year-end Fed Funds rate estimated at a minimum of 2.5% and above 3.0% into 2023.

Is the next shock for markets a possible US recession in 2023? Coupled with a potential fiscal shock as government’s remove the unprecedented pandemic stimulus programs – some commentators have started to flag this threat is escalating. One major global forecaster now expects the US economy will record negative growth in the latter part of next year. Bond markets have reacted to the expected move by central banks with the US and AU 10 year yields selling off to the highest levels in four and eight years respectively. As rates rise across the curve the challenge for corporates will be this translating into higher borrowing costs, combined with a possible slowing economic growth outlook. For investors, it will be the appropriate equity valuations especially for the high multiple growth names.

Bond Yields Movement over Past 5 Years,%

The US 1Q22 corporate reporting season is underway and has recorded positive growth. To date we have seen more EPS beats versus analyst estimates, but some of the mega-Tech names have either missed expectations and/or have given weaker guidance for Q2, pressuring US equity indices. For the quarter, the current estimate is for a 7% YoY earnings increase. The CEO of JPMorgan Chase noted in their results commentary that the economic growth outlook for Q2 and Q3 remains intact with healthy corporate and consumer cash levels, however beyond that he flagged increasing challenges as the FED responds with rate hikes to combat soaring inflation.  

In our latest June quarterly outlook we reduced our equity weighting to both the US and EU markets, whilst retaining a mild overweight to AU. We remain comfortable with this exposure given the composition of the respective indices – the broad US S&P500 is more heavily focused to tech names, whereas the ASX200 with its concentrated focus to resources, energy and domestic banks, is supportive for the local market. Additionally, the government’s ongoing commitment to infrastructure spending validates our overweight stance in this asset class.

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