The March quarter brought increased volatility with equity and bond markets undergoing major corrections. Rising inflation and interest rates were the main drivers, along with Russia’s invasion of Ukraine, which raised geopolitical tensions and exacerbated inflationary pressures. Sanctions on Russia will lead to reduced global supply of commodities (coal, oil, gas, metals and wheat) which particularly impacts Europe, the Middle East and North Africa. The geopolitical repercussions of Russia’s invasion were also wide ranging with the West likely to rethink the security of its supply chains and its borders.
Headline inflation in the US has reached 7.9% and the US Federal Reserve (the Fed) is taking an increasingly hawkish tone. This has seen bond yields rise rapidly, leading to weakness in bond prices and pressure on equity market valuations, particularly growth stocks.
Commodities, particularly coal, oil and gas, have rallied in response to Russian sanctions.
US equity markets were down 15-20% by mid-March but have since staged a rally ahead of the US 1Q22 profit season. Global infrastructure has rallied, despite rising bond yields, as social restrictions relating to the COVID pandemic are relaxed. The US yield curve has risen rapidly, with the 2-year note currently at 2.5%, indicating the market expects the Fed to increase the cash rate to over 2.0%, within 18 months. As mentioned above, rising bond yields lead to falling bond prices, hence bond funds have moved into negative territory over the past year. However, bonds now offer higher yields and will soon become attractive to new money.
China is still dealing with COVID issues and has been implementing hard lockdowns, which will continue to cause issues for global supply chains. China also has property market issues in the background and has been easing policy, as the rest of the world tightens. This has seen Asian markets rally off their lows in late March.
The Australian share market outperformed global markets over the March quarter, due to a heavy exposure to resource and energy stocks, which make up around 25% of the market. Indeed, the Australian economy is performing well, despite recent floods in QLD and NSW.
Inflation is rising in Australia but at 3-4%, is less of a problem than in the US. That said, the RBA seems to be preparing to lift the cash rate in the second half of 2022. Australian interest rates and the currency have already been rising in anticipation of a more hawkish RBA.
The Federal government has called the Federal election for 21 May 2022, about as late as it can be! The Federal government’s slow response to the COVID pandemic and recent floods has added pressure on the Morrison government, which continues to lag Labor in the polls. It seems a change of government might be ahead, unless the Prime Minister can pull a rabbit out of the hat (again)!
The Australian economy should continue to benefit from a recovery from the COVID pandemic, buoyant commodity prices and moderate fiscal stimulus announced in the recent Federal Budget. On the negative side, inflation and interest rates are rising and the housing market seems to be already slowing. Recent floods will also impact the QLD and NSW regions.
A key question that arises from the March quarter is:
Does increased market volatility indicate the end of the bull market in equities?
The answer nobody knows, as the future is uncertain.
“Predictions are difficult, especially about the future” Niels Bohr
One can only take a view and observe events as they unfold. Our view is that the bull market does look late cycle; rising inflation and interest rates pose major challenges for company margins and market valuations. The positives are that economic growth is strong and should remain so (due to a recovery from the COVID pandemic) and company balance sheets are in good shape.
This bull market began post GFC, in March 2009, and has been running for 13 years straight (with a couple of major corrections in 2018 and 2020). Long running bull markets usually don’t die overnight and can continue, even with rising interest rates. We remain cautiously optimistic on the outlook for equities, but we are also wary that we could be witnessing the beginning of a new bear market. Such events are only known in hindsight, 1-2 years later.
The major positives are that COVID restrictions are being relaxed and fiscal policy remains accommodative. Inflation is running hot but should peak by mid-year and start to fall in the second half of the year, as supply chain problems are gradually resolved, while energy prices may also retreat.
We acknowledge the risks are to the downside, but we remain cautiously optimistic and expect a ‘muddle through’ situation during the year. We would need to see a growth shock or an interest rate shock to be more bearish and that is not our base case, at this stage. We just don’t see central banks increasing interest rates as fast as the market seems to be implying.
The key known risks ahead seem to be:
COVID pandemic (should fade in 2022);
Inflation (supply chain, energy, labour dislocation);
Fed tightening (increasing the cash rate and quantitative tightening);
China (property bubble and COVID lockdowns);
Regulatory interventions (in various sectors); and
Geopolitical tensions (Russia/China vs the West).
The next key events on the calendar include:
US 1Q22 profit season – April 2022
RBA meeting - 03 May 2022
US Federal Reserve meeting - 4/5 May 2022
Australian Federal election - 21 May 2022
Principal, Portfolio Manager
Bill Keenan is the founder of Sunbird Portfolios (previously Bluebird Portfolio Services). Sunbird provides independent advice to leading financial advisers across Australia.
Bill has 28 years’ experience in financial markets and holds a Bachelor of Business in Accounting and a Graduate Diploma in Finance and Investment.