Market volatility in 2023 has been like Episode 70, Part Two of a sit-com series started in 2022. What the market made in January of this year has now been all but given up in February with volatility continuing to put investors at unease.
In my write-up in our December 2022 Newsletter, I had alluded to the possibility of a recession in the second half of 2023, as well as downward pressure on housing prices in Australia. We also spoke about the resilience of the labour market both overseas (particularly in the US) as well as here in Australia and that has continued to be the case. Given the continued focus on raising rates by the Federal Reserve in the US, the probability of a recession in the US in coming months has increased. However, the market consensus is still for a mild recession at this stage.
As per my write-up post the Chief Economists’ Forum last month, based on general consensus amongst the various economists who presented, a positive outcome from equity markets towards the end of this calendar year is expected. However, I should point out that, once again, this is a view only and no one can predict the actual outcome with any definitive certainty.
The cost of living globally has increased due to price pressure from a clogged supply chain and slowdown in manufacturing over the covid period. Whilst the job market is extremely resilient, further pressure from increasing mortgage rates and hence repayments, will continue to drive cost of living headaches. This will result in a decrease in discretionary spending, a fall in the savings rate, and also potentially increasing the bad debts for the banks in due course.
Recent announcement from China of an estimated and targeted GDP growth of ‘around 5%’ has caused markets to pare recent gains. This was lower than expected from the World’s Growth engine. For an economy of its size, that rate of growth, under normal circumstances, would be considered a respectable target. However, the world seems to be walking on eggshells and seems to be sensitive to everything in its current state!
Inflation continues to allude the Reserve banks globally with recent figures in the US printing on the upside whilst tapering off only slightly in Australia. This, along with continued strength in company profits and supply-chain disruptions still posing issues, has led the market to price in further rate hike expectations with the terminal rate (at the end of the cycle) now at about 5.5% in the US.
This is about 1% higher than where expectations were at the beginning of 2023 and continuing to cause market gyrations due to concerns around the economy slowing down resulting in a recession. This is largely based on sentiment (as there is no certainty on the number and size of rate hikes the Federal Reserve will do and the direct impact on the economy is not a given) and is driving market movements and creating significant uncertainty and hence volatility. In Australia, the terminal rate is lower at around 4.25% as show below.
Source: Bloomberg, Mutual Funds
Our RBA has increased the rate by an expected 0.25% today to 3.60%. Governor Lowe cited global inflation, a tight labour market, increasing rental pressures, and continued business investment and optimism as the reasons for the increase. The RBA needs to get ahead of the curve to ensure inflation doesn’t run rampant, making it incredibly difficult to reign in later. However, he did also state that inflation in Australia has peaked, and this provides some comfort.
The Fed starts its 2-day testimonial tomorrow and markets will be hanging on every word. If inflation is getting under control, markets are likely to rally. Off course, if inflation and labour market strength is still persistently stubborn, the opposite is just as likely.
Focus needs to remain firmly on fundamentals when constructing investment portfolios and taking a long-term approach. Wading through the ‘noise’ generally always pays off in due course. There are always opportunities in any market condition, and we need to mitigate downside risk whilst keeping the opportunities front and centre.
As always, stay safe and stay well!
“It is possible to make money— and a great deal of money—in the stock market. But it can’t be done overnight or by haphazard buying and selling. The big profits go to the intelligent, careful and patient investor, not to the reckless and overeager speculator.” —J Paul Getty