Since their lows in June, global and Australian equities have run hard and are vulnerable to a pullback over the coming months.
- Central banks are still a long way from peaking and actually cutting rates; the risk of recession continues to increase (as evidenced by the inversion of the US yield curve);
- This runs the risk of significant earnings downgrades;
- The period from August to October is seasonally weak for equities; and
- Geopolitical risk is still on the rise with escalating US-China tensions over Taiwan, the ongoing war in Ukraine and the upcoming US midterm elections.
On the positive side of the equation:
- Growing Signs of US Inflation Spike;
- around 20% drop in the stock markets having perhaps already anticipated a slight recession; and
- The strength of the rebound itself maintains the possibility that we have seen the bear market lower and that any pullback is only a partial retracement of the rally from mid-June which then bottoms out above the June low and sees the upward trend continuing.
Time will tell us. Year over year, equities should be stronger as central banks stop raising rates and recessionary outcomes diminish. But the short-term uncertainty is very high and the risks are on the downside.
Inflation and the risk of recession remain the main issues for investment markets. Last week:
- Chinese economic data surprised on the downside and US data was mostly soft, keeping recession risk elevated.
- The Reserve Bank of New Zealand raised its benchmark rate by 0.5% to 3% and sounded even more hawkish. Norway’s central bank also rose 0.5%.
- Further increases in inflation in the UK and Canada left central banks in both countries on track for further rate hikes.
- Minutes from the Fed’s latest meeting remained hawkish, announcing more rate hikes to come with no sign of an impending “pivot” to looser policy, but signaled an awareness of the risk for growth and the need for a possible slowdown in monetary tightening as policy evolves. restrictive territory to avoid overtightening.
- Similarly, the minutes of the last RBA meeting continued to point to further increases, but reiterated that it was “not on a pre-determined path”. It also appears to be more aware of the downside risk weighing on growth, including for households.
- Australian data did not provide a firm lead on what the RBA will do at its September meeting – unemployment fell to a new 38-year low of 3.4%, but employment also fell ( probably due to the impact of covid and flu illnesses and floods) and if wage growth picks up, we are far from a wage-price spiral.
As we look to the RBA’s rise another 0.5% next month, we think it’s unclear whether it will rise another 0.25%. Given the lags involved in the impact of monetary policy on the economy – many households have not seen the full impact of rate hikes so far and the fixed rate cliff has yet to take hold. he impact mainly next year – and the hit to real wages – it makes sense for the RBA to slow the pace of tightening to allow time to assess the impact of rate hikes so far.
With medium-term inflation expectations remaining low, the RBA now has room to slow down. A move of 0.4% might be a good compromise (and bring the cash rate down to a more “normal” number). The futures market is currently anticipating a rise of 0.38% in September. We still see the cash rate peaking at 2.6% later this year or early next.
Monitoring of economic activity
Our Australian economic activity tracker fell again over the past week and continues the loss of momentum seen since April, in line with a slowdown in growth. Our US tracker was up slightly and our European tracker was down slightly.
Australian economic events and implications
We continue to expect accelerating wage growth going forward because:
- Labor slack is at levels consistent with wage growth of 3-4%;
- Salary growth, including bonuses, reached 3.1% year-on-year, the highest since 2013;
- Rising private sector jobs recorded an average gain of 3.8%, compared to 2.7% a year ago, but it still takes time for this to materialize given the multi-year EBAs;
- The 4.6% and 5.2% increases in the minimum wage will push wages up from the current quarter; and
- Many surveys and anecdotes point to faster salary growth ahead.
As a result, we see wage growth pick up within 3 over the next year. This will still be well below the kind of wage growth already seen in the US and Europe, suggesting that a wage-price spiral is a much lower risk in Australia, meaning the RBA will not have not raise rates as much as the Fed.
The Australian half of June earnings season has now seen around 65% of corporate earnings according to the market capitalization report. The overall results are a bit weak and they have slowed since the initial recovery after the pandemic shutdowns.
So far, only 33% of results have surprised on the upside, 58% have seen earnings rise from a year ago and 52% have increased dividends, all of which are below average, reflecting pressures on the costs that some companies face. As a result, only 45% of companies saw their stock prices outperform the market on the day of the earnings release, well below the norm of 54%. A significant proportion of companies have posted earnings growth below inflation this year.
What to watch next week?
August PMIs for the US, Europe, Japan and Australia will be released on Tuesday and will likely show further signs of slowing down. Hopefully pricing pressures, supplier delivery delays and work backlogs have improved further, adding to signs of a spike in inflationary pressure.
The annual gathering of central bankers in Jackson Hole, Wyoming (Thursday through Saturday) where the topic is “Reassessing Constraints on Economics and Politics” will be closely watched. for any change in direction on global monetary policy – but his likely central bankers, including Fed Chairman Powell, will remain hawkish on inflation, although a bit of caution is setting in given the emerging economic slowdown .
In the US, the private final consumption deflator core inflation for August (Friday) is expected to show a 0.3% y-o-y increase, with annual inflation remaining unchanged at 4.8% y-o-y adding to signs that inflation may have peaked. Personal spending and income should continue to show modest growth. Durable goods orders for July (Wednesday) will likely post a further increase and home sales data (Tuesday and Wednesday) should remain weak.
Australia’s mid-June earnings season will hit its busiest week with around 100 major companies due to report. Consensus expects earnings growth of around 20% for FY 2021-22, driven by Energy (+275%) and Industrials earnings with average growth of around 9.5% . The focus will likely be on forward-looking statements given cost pressures, labor shortages and slowing consumer demand.