Investment markets & key developments

The global share market rebound faltered a bit over the last week with mixed economic data and mostly hawkish messages from central banks. US and European shares were little changed, Japanese shares rose and Chinese shares fell. The Australian share market rose solidly though helped by strong earnings results for some companies led by strong gains in retail, resources and industrial stocks. Bond yields generally rose, although they fell a bit in Australia. Oil, metal and iron ore prices fells. The $A also fell as the $US rebounded.

From their June lows global and Australian equities have run hard and are vulnerable to a pull back over the next few months having become overbought and coming up against technical resistance from the downwards sloping 200 day moving average for the US shares market. More fundamentally: central banks are still a way off from peaking and actually cutting rates; recession risk is still rising (as evident in the inverting US yield curve); this runs the risk of significant earnings downgrades; the August to October period is seasonally weak for shares; and geopolitical risk is still on the rise with the escalation in China/US tensions over Taiwan, ongoing war in Ukraine and the upcoming US mid-terms. On the positive side of the equation: increasing signs of a peak in US inflation; 20% or so falls in share markets possibly having already anticipated a mild recession; and the strength of the rebound itself maintain the possibility that we may have seen the bear market low and that any pull back may just be a partial retracement of the rally since mid-June which then bottoms out above the June low and sees the rising trend continue. Time will tell. On a 12 month view shares are likely to be stronger as central banks stop hiking and move to cutting and as recession should be avoided or if not its likely to be mild. But short term uncertainty is very high and the risks are on the downside.

Inflation and recession risk remain the main issues for investment markets. In the past week:

• Chinese economic data surprised on the downside and US data was mostly soft further keeping recession risk high.
• The Reserve Bank of New Zealand hiked its cash rate another 0.5% to 3% and sounded even more hawkish. Norway’s central bank also hiked by 0.5%.
• Further increases in inflation in the UK and Canada left both countries central banks on track for more rate hikes.
• The minutes from the last Fed meeting remained hawkish foreshadowing more rate hikes ahead with no signs of an imminent “pivot” to easier policy, but signalled awareness of the risk to growth and the need for an eventual slowing in monetary tightening as policy moves into restrictive territory to avoid over-tightening.
• Similarly, the minutes from the last RBA meeting continued to flag more hikes but reiterated that its “not on a pre-set path”. It also appears more conscious of the downside risk to growth including for households. Australian data didn’t 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 (likely due to the impact of covid and flu illnesses and floods) and while wages growth is picking up it’s a long way from a wage price spiral. While we lean to the RBA hiking by another 0.5% next month, we think it’s a close call as to whether they hike by 0.25%. Given the lags involved in how monetary policy impacts the economy – many households have not seen the full impact of the rate hikes so far and the fixed rate cliff is yet to impact mostly next year – and the huge blow to real wages, it makes sense for the RBA to slow the pace of tightening to give time to assess the impact of the rate hikes so far. With medium term inflation expectations remaining low the RBA now has some scope to slow down. Moving by 0.4% might be a good compromise (and return the cash rate to a more “normal” number). The futures market is currently pricing in a 0.38% hike in September. We still see the peak in the cash rate being 2.6% later this year or early next.

While the recession risk is high globally (and probably around 30% for Australia), the good news is that upstream price pressures are continuing to show signs of cooling with global business surveys showing improving delivery times, falling order backlogs and falling price and cost pressures along with falling oil and metal prices. This is being reflected in an ongoing downtrend in our Pipeline Inflation Indicator. This should start to take pressure of central banks and at least allow a slowing in tightening in the next six months – hopefully in time to avoid deep recessions.

The ABS announced details of its new monthly CPI. It will commence publication with the September quarter release at the end of October and will continue monthly thereafter and it will use monthly data (including for food, rents, petrol and travel) each month for between 62-73% of the weight of the CPI. Based on data for the last four years annual movements in it align closely to the quarterly CPI.

But while it may help lead the quarterly CPI at turning points there are four reasons to be cautious in interpreting it – at least initially: it will only have updated data for 2/3rds of the CPI; this means it will be revised as more complete data becomes available; it’s extremely volatile month to month – see the next chart; and there will be no trimmed mean or median available initially. Consistent with this the ABS is seeing it as an indicator of the CPI inflation with the quarterly CPI being regarded as the key measure of inflation. As a result its unlikely to replace the quarterly CPI as the key driver of the RBA policy.

For those on the East Coast of Australia worried about the more rain, the Southern Oscillation Index has fallen back but it remains at levels associated with La Nina (i.e. wet).

In Australia, new covid cases are continuing to trend down.

Economic activity trackers

Our Australian Economic Activity Tracker fell again over the last week and continues the loss of momentum seen since April, consistent with a slowdown in growth. Our US Tracker rose slightly and our European Tracker fell slightly.

Major global economic events and implications

US data was mostly soft. Industrial production rose solidly in July. Retail sales were strong excluding autos and gas, but this looks due to an exaggerated rise in online sales and real retail sales are weak. The Philadelphia regional manufacturing conditions index rebounded in August after falling sharply in July, but the New York regional survey was very weak and the trend in both is down. Home builder conditions continued to fall, housing starts fell sharply and existing home sales fell. Initial jobless claims fell but continuing claims rose. CEO confidence fell back to 2020 lows. And finally, the US Leading Index fell for the fifth month in a row. Mixed indicators are often seen at turning points but the overall impression is that the risk of recession is continuing to rise – as indicated by the leading index (next chart). The good news is that regional manufacturing surveys showed a further fall in price pressures.

Canadian CPI inflation slowed in July to 7.6% but underlying measures rose further to a new record high (since 1990) of 5.3%yoy on average. The BoC is likely to raise rates by 0.75% again when it meets in September.

UK July inflation rose to 10.1%yoy, with core inflation rising to 6.2%yoy, keeping the BoE on track for more 0.5% hikes.

Japanese GDP returned to growth in the June quarter after the Covid affected March quarter. July CPI inflation rose to 2.6%yoy but excluding food and energy its just 0.4%yoy.

The Reserve Bank of NZ hiked its cash rate by an as expected 0.5% taking it to 3%, and despite more downgrades to the growth outlook was more hawkish than expected now flagging a rise in the cash rate to 3.75% by year end. NZ is likely to see a a more abrupt end to rate hikes and more rapid reversal than the RBA when the turn eventually comes.

Chinese economic activity data for July was weaker than expected with growth in industrial production, retail sales and investment all falling and home prices continuing to fall. Reflecting the renewed slowdown in growth the PBOC cut its key 1 year lending rate by 0.1% to 2.75%. It wasn’t much of an easing but given the weakness further policy stimulus is likely.

Australian economic events and implications

Australian jobs data was messy in July, but the jobs market remains tight. While employment and hours worked fell this looks to reflect the combination of school holidays, a spike in covid and flu absences and more floods in NSW. Meanwhile, the unemployment rate fell to a new 38 year low of 3.4% and labour underutilisation fell to 9.4% (its lowest since 1982) and the ABS noted that in July there were fewer unemployed (474,000 people) than there were job vacancies in May (480,000) all of which suggests the job market remains very tight for now. We continue to see the unemployment rate falling further to 3.2% in the months ahead before rising next year in response to slower growth.

However, wages growth remains relatively soft rising to just 2.6%yoy in the June quarter which means a fall in real wages of 3.5%yoy. This was slightly weaker than expected but in line with RBA forecasts.

We continue to expect a pick-up in wages growth going forward: labour underutilisation is at levels consistent with 3-4% wages growth; wages growth including bonuses rose to 3.1%yoy which is the highest since 2013; private sector jobs seeing a rise saw a 3.8% average gain which is up from 2.7% a year ago but it always takes time for this to flow through given multiyear EBA’s; the 4.6% and 5.2% minimum wage increase with push wages up from the current quarter; and numerous surveys and anecdotes point to faster wages growth ahead. As a result we see wages growth picking up into the 3’s over the next year. This will still be well below the sort of wages growth being seen already in the US and Europe suggesting a wage-price spiral is a far smaller risk in Australia which means the RBA won’t have to raise rates as much as the Fed.

The Australian June half earnings reporting season has now seen around 65% of company profits by market capitalisation report. Overall results are a bit soft, and they have slowed down since the initial recovery from the pandemic lockdowns. So far only 33% of results have surprised on the upside, 58% have seen earnings up on a year ago & 52% have increased dividends all of which are below average reflecting the cost pressures some businesses are facing. Reflecting this only 45% of companies saw their share prices outperform the market on the day results were released which is well below the norm of 54%. A significant proportion of companies have flagged earnings growth this year below inflation.

What to watch over the next week?

Business conditions PMIs for August for the US, Europe, Japan and Australia will be released on Tuesday and will likely show further signs of a slowdown. Hopefully, pricing pressures, supplier delivery lags and work backlogs with have improved further adding to signs of a peak in inflation pressure.

The annual central bankers’ gathering in Jackson Hole, Wyoming (Thursday to Saturday) where the topic is “Reassessing Constraints on the Economy and Policy” will be watched closely for any change in direction regarding monetary policy globally – but its likely central bankers, including Fed Chair Powell, will remain hawkish in dealing with inflation albeit with a bit of caution creeping in given the emerging economic downturn.

In the US, core private final consumption deflator inflation for August (Friday) will likely show a 0.3%mom rise with annual inflation remaining unchanged at 4.8%yoy adding to signs that inflation may have peaked. Personal spending and income is likely to show continued modest growth. Durable goods orders for July (Wednesday) will likely show a further rise and home sales data (Tuesday and Wednesday) is likely to remain soft.

The June half Australian earnings reporting season will hit its busiest week with around 100 major companies due to report covering around 25% of market cap including Lendlease, Nick Scali and Sonic (Monday), Ansell, Boral and Scentre (Tuesday), Coles, Nine, Worley and Seven (Wednesday), Blackmores, Flight Centre, South32 and Woolworths (Thursday) and Wesfarmers (Friday). Consensus expectations are for around 20% earnings growth for the 2021-22 financial year but with this boosted by energy earnings (+275%) and industrials averaging around 9.5% growth. The focus will likely be on outlook statements given cost pressures, labour shortages and slowing consumer demand.

Outlook for investment markets

Shares remain at high risk of a pull back in the months ahead as central banks continue to tighten to combat high inflation, uncertainty about recession remains high and geopolitical risks continue. However, we see shares providing reasonable returns on a 12-month horizon as valuations have improved, global growth ultimately picks up again and inflationary pressures ease through next year allowing central banks to ease up on the monetary policy brakes.

With bond yields looking like they have peaked for now short-term bond returns should improve a bit further.

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). Unlisted infrastructure is expected to see solid returns.

Australian home prices are expected to fall 15 to 20% top to bottom into the second half of next year as poor affordability & rising mortgage rates impact.

Cash and bank deposit returns remain low but are improving as RBA cash rate increases flow through.

The $A is likely to remain volatile in the short term as global uncertainties persist. However, a rising trend in the $A is likely over the medium term as commodity prices ultimately remain in a super cycle bull market.