Welcome to our Autumn edition of On the Marc. In this edition, we will review markets for the final quarter of the 2021 calendar year and consider the outlook for the foreseeable future.

Market update 

The Australian market closed out the quarter with the S&P/ASX 200 up 6.9% in March and all 11 sectors finishing positively. The Technology sector (+13.2%) led the index and rebounded from a February selloff, with Energy (+9.8%), Materials (+8.9%), Financials (+8.5%) and Utilities (+7.6%) all performing strongly. The Energy and Materials sector continued its stellar year-to-date performances as commodity prices continued to soar. Meanwhile, Information Technology rebounded strongly from a perceived ‘bottom’ in February amidst rising interest rate pressures in overseas markets. However, volatility in this sector persisted given the uncertain macroeconomic backdrop. The Financials sector continued its sturdy performance as the major Australian Banks contributed to the strong Australian broad market performance. The S&P/ASX 200 finished the month within 2% of its August 2021 historical high. Overall, while the geopolitical issues in Ukraine remain a point of concern, Australian equity performance has been more robust than other markets with greater geopolitical risk.

We have seen more high inflation numbers and hawkish comments from central banks. Canada had a further sharp increase in inflation to 6.7% yoy (year on year) and NZ inflation to 6.9% yoy in March will keep their central banks on track for further rate hikes. Comments from Fed officials continue to point to more aggressive rate hikes ahead taking the Fed Funds rate to “neutral” or above, with Chair Powell saying a 0.5% hike is “on the table” for May and indicating support for the idea of “front-end loading” rate hikes.

While European Central Bank President Lagarde was balanced in her comments, several ECB council members were hawkish leaning toward a rate hike in the September quarter.

Domestically the RBA minutes confirmed that it is gearing up for the start of rate hikes with it noting that higher inflation and wages growth “has brought forward the likely timing of the first increase in interest rates.”

March quarter Australian inflation data will be released on Wednesday and is likely to add further pressure on the RBA to start raising rates. Our base case remains that the first RBA rate hike will be 0.15% taking the cash rate to 0.25% and coming in June as the RBA will prefer to avoid hiking in the election campaign and wants to see March quarter wages data due on the 18th May before moving. It is now a very close call as to whether the first hike will be in May or June. Business surveys and numerous anecdotes of price rises point to another surge in inflation in the March quarter. We are expecting an increase in the CPI of 4.6% yoy for the March quarter. This is well above implied RBA expectations from February.

The further blowout in Australia means that Australia is now starting to face the same risk as in various other countries that inflation expectations will get out of control locking in higher than target inflation, making it even harder to get inflation back down again. As such if inflation comes in around our forecasts there will be a strong case for the RBA to hike in May and that the first hike should be 0.4% (taking the cash rate to 0.5%) as 0.15% won’t send a particularly strong signal in terms of its resolve to keep inflation expectations down. By year-end market expectations are for a rise to 2.3%. The following chart shows interest rate expectations for Australia and the US over the next two years.

The good news is that recession looks like it can be avoided in the next 12 months, and this should enable shares to be higher on a 12-month horizon. While Europe is most at risk of recession, so far our European Economic Activity Tracker is still rising.

March quarter US earnings are coming in far stronger than expected again. 18% of US S&P 500 companies have reported December quarter earnings with 80% beating expectations (compared to a norm of 76%). Consensus earnings expectations for the quarter have moved up from 4.3% yoy a week ago to now 5.5% yoy but with the average beat running at around 8% it is likely to end up at around 12% yoy. This is well down from the growth pace seen in the previous four quarters but they were pushed up by the initial recovery from the pandemic. Energy, materials and industrials are seeing the strongest earnings growth. The continuing strength in earnings is proving to be an ongoing source of support for the US share market – key to watch going forward will be the impact of rising costs.

Base effects (where very high CPI increases a year ago start to drop out of year-on-year calculations), a rolling over in petrol prices, easing shipping costs and used car prices and rising inventory levels suggest we may have seen the peak in year-on-year inflation in the US and this will likely apply to other countries too – albeit with a lag as we don’t expect Australia inflation to peak to mid-year.

Inflation will still be too high to stop short term monetary tightening but peaking in inflation may allow some slowing in the pace of rate hikes later this year.

While the IMF downgraded its global growth forecast to 3.6% for this year from 4.4% and revised its inflation forecasts up, this is old news as private forecasters and investment markets had already moved to factor it in. The revision was mainly due to the disruption to economic activity and boost to inflation from the invasion of Ukraine. Russia’s growth forecast was revised to -8.5% and European growth were revised down to 2.8%. The IMF’s growth forecast for Australia was revised up to 4.2% (our forecast is 4.5%) – one of the few major countries to see an upgrade!

On the Covid front hospitalisation and death rates generally remain low across various major countries compared to pre-Omicron waves, with vaccines and prior exposure providing protection against serious illness, better treatments and the Omicron variants being less harmful than prior covid variants. 59% of the global population is now vaccinated with two doses and 23% have had a booster. In developed countries, it’s 75% and 47%, with Australia at 84% and 52%. The main risk remains the mutation of a more contagious and more harmful variant in lowly vaccinated poor countries where vaccination rates are only rising very slowly.

Chinese economic activity data slowed in March by less than expected, but further weakness is likely. March quarter GDP growth came in slightly stronger than expected at 4.8% yoy and industrial production and investment slowed in March but by less than expected. However, March retail sales contracted by 3.5% yoy and unemployment rose. With covid lockdowns expanding and continuing into this quarter and high-frequency weekly data running well below year-ago levels a further sharp slowing in growth is likely. More policy support is likely but the PBOC (with just a 0.25% cut to bank required reserves last week and no cut to interest rates) appears reluctant to be too aggressive so much of the focus will likely be on credit easing and fiscal stimulus.

Market returns for major indices

Below is a table showing the percentage returns of the major market indices to 31st March 2022.

The outlook for the year ahead 

Shares are likely to see continued volatility as the Ukraine crisis continues to unfold and inflation, monetary tightening, the US mid-term elections and geopolitical tensions with China and maybe Iran impact. However, we see shares providing positive returns on a 12-month horizon as the global recovery continues, profit growth slows but remains solid and interest rates rise but not too onerous levels at least for the next year. Low yields & a capital loss from a further rise in yields are likely to result in negative returns from bonds.

Unlisted commercial property may see some weakness in retail and office returns (as online retail activity remains well above pre-covid levels and office occupancy remains well below pre-covid levels), but industrial property is likely to be strong. Unlisted infrastructure is expected to see solid returns.

Australian home price gains are likely to slow further with average prices falling from mid-year due to poor affordability, rising mortgage rates, reduced home buyer incentives and rising listings impact. Sydney and Melbourne's prices are likely to have already peaked.

Cash and bank deposits are likely to provide poor real returns, given the historically ultra-low cash rate.

A rising trend in the Australian Dollar is likely over the next 12 months helped by strong commodity prices, taking it closer to $US0.80.

Did you know?

The rotation from growth companies to value companies continued in the first quarter of the 2022 calendar year. Goldman Sachs ran an analysis of the performance of US technology companies that run at a loss. The below chart shows the performance since April 2017. We can see the exuberance from February 2020 (start of Covid) for the following 12 months. Since February 2021 these companies overall traded sideways before the ongoing sell off since October 2021.

Ever wondered what the ideal speed is for a car in optimising fuel consumption efficiency? Australian fund manager Firetrail completed research on this and the sweet spot is between 60 -70 km/h.

Final reMarc

Years of accommodative monetary policy combined with ample liquidity from central banks, remnants of the global financial crisis of 2008, maybe coming to a gradual end. We are entering a transition period in the economic environment from one of low inflation, low-interest rates backed by unconventional monetary policy (quantitative easing), to one of higher inflation and the potential of higher interest rates.

Adding fuel to inflationary pressures has been a global pandemic where supply chains have been disrupted like never before, heightened geopolitical risks with the Russian invasion of Ukraine, known as the breadbasket of Europe, putting price pressures on everything from crude oil, wheat to sunflower oil, and globalisation, the accepted mantra for economic growth for decades, which is now under increased scrutiny with talk of a deglobalised world. Periods of transition from a market perspective are always challenging. They are characterised by increased uncertainty and subsequently increased market volatility.

The outlook remains optimistic. From an economic sense, the war in Russia/Ukraine is a huge positive for our domestic economy thanks to soaring commodity prices resulting in the government collecting significantly higher taxes than expected (thanks due to significantly higher company profits).

We are expecting mundane returns from property and shares into the foreseeable future and believe active management through utilising several specialist fund managers remains the cornerstone in seeking positive returns while managing downside volatility.

“Janitors work hard. Backline cooks work hard. Hard work helps you win your game. Choose the right game.”

Shaan Puri

Key Facts & Figures

1. Australian Cash Rate remains at the record low of 0.10%.

2. The RBA Cash Rate is expected to increase seven times in the 2022 calendar year.

3. Our annualised inflation rate is 3.5%. This is above the upper end of the RBA’s target band of 2 - 3%.

4. Australia’s unemployment rate remains at 4.0%.

5. The Federal Reserve cash rate range has risen from the record low and currently is between 0.25% and 0.50% in the US. The Federal Reserve cash rate forecast is 1.90% by the end of 2022.