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Monthly Market Update - September 2022


Global


Australian and Global shares surprisingly finished flat over the September quarter but that belied the underlying volatility of the market. There was a strong rally in July/August on hopes of an inflation retreat and a more dovish Fed, only to be doused by rising core inflation and an even more hawkish Fed. Financial markets retreated sharply in September.


Market volatility has increased steadily throughout 2022. The main issues behind the volatility include:

  1. Rising inflation;

  2. Rising interest rates;

  3. The Russian/Ukraine war; and

  4. A slowdown in China (COVID lockdowns and Property downturn).

The Russian/Ukraine war has exacerbated food and energy inflation, while China’s lockdowns have continued to upset supply chains. While there is some hope that headline inflation will ease, core inflation continues to rise, suggesting inflation pressures are broadening. This has caused Central Banks to recently ‘double-down’ on tightening monetary policy, even at the expense of growth and employment, in an effort to ‘get ahead’ of inflation. The aim is to reduce aggregate demand so that prices eventually fall.


The US Federal Reserve recently increased the US cash rate to 3.25% and is expected to be at 4.25-4.50% by the end of 2022. This has caused a major rally in US interest rates and the US dollar. The US 10-year bond yield has risen from 1.5% to nearly 4.0% this year. The US bond yield sets the minimum return for all assets. For example, stocks are commonly priced at a 6% risk premium to bonds.


This means the required return or discount rate for stocks has increased to ~10% from 7.5%, over the year. In turn, market valuations have had to fall across equities (and indeed most growth assets).


In addition, the rise in US interest rates has led to a rally in the US dollar. Given currencies are measured relative to each other, most other currencies have depreciated. This has the effect of ‘exporting inflation’ to other countries because they have lost purchasing power and capital will also flow out of these countries back to the US. This is the reason behind Japan and China intervening in currency markets to support their currencies. Recent UK issues were related to a surprise expansionary fiscal budget in contrast to the Bank of England, which wanted to slow the economy to defeat a 9.9% inflation rate. The UK government has had to change its plans in response to the adverse market reaction to its stimulus package.


As mentioned above, rising interest rates have been the main cause of volatility in growth assets and bond funds. Growth assets fall in value on higher discount rates, while bonds fall in value to reflect the higher yields on offer (bond prices move inversely to bond yields). As a result, nearly all asset classes have moved lower over 2022 (only cash and commodities have proven resilient).


Australia


The Australian economy remained robust to the end of June on strong commodity prices and a recovery in consumer spending. The Federal Government is due to provide a Budget update in late October, with the budget deficit expected to be ~$50bn better than expected due to strong commodity prices (particularly coal and LNG).


However, inflation remains elevated at ~7% and the RBA has lifted the cash rate to 2.60% and looks to be headed to 3.10% by the end of 2022. We expect the variable home loan rate to hit 4.95-5.00% by the end of the year. Higher interest rates are yet to fully impact the household sector as ~30% are on fixed rate home loans that mature over the next six months. COVID issues are fading but flooding continues to be a problem with a La Nina weather pattern parked over the East Coast of Australia.


The Labour market remains tight with the unemployment rate at 3.5%. However, wage inflation remains reasonably contained thus far. The strong employment market and a recovery from COVID seems to be making it hard for the Central Bank to slow demand and hence prices.


However, many leading indicators are moving lower, including consumer confidence, house prices and the share market. Consumer spending should slow materially by early 2023, as the full impact of higher costs and mortgage repayments impact households.


Outlook


Market volatility has increased primarily due to high inflation and rising interest rates. Events in Europe and China have exacerbated the problem. Central Banks are aiming to get inflation down quickly by raising interest rates sharply, which is making conditions challenging for most asset classes.


That said, the seeds of the next bull market are being sown as market valuations fall and interest rates likely reach a peak, sometime in 2023. Growth assets will recover in anticipation of core inflation falling and Central Banks ‘pivoting’ from tightening to easing. When this happens is impossible to time perfectly. It is best to stay mostly invested and to consider the income that will continue to be generated by equity, property and infrastructure assets. Capital losses are only losses if realised and it is best to stay the journey for when inflation retreats.


We expect markets to remain volatile for most of FY23, but this will present opportunities ahead of the next bull market. We are positioned defensively and will be on the lookout for such opportunities as they arise.


The next key events on the calendar include:

  • US 3Q22 reporting season – October 2022

  • Australian Federal Budget update – 25 October 2022

  • RBA meeting – 01 November 2022

  • Australian AGM and Bank reporting season – November 2022

  • Fed meeting – 01/02 November 2022

  • G20 meeting in Bali – 15 November 2022

Bill Keenan

Principal, Portfolio Manager


Bill Keenan is the founder of Sunbird Portfolios. 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.


Warnings


General Securities Advice - any advice provided in this document, is general in nature only and does not take into consideration an investor’s objectives, financial situation or needs. Before acting on the advice, the reader must consider whether it is personally appropriate considering his or her financial circumstances or should seek independent financial advice on its appropriateness.


Past performance is not a reliable indicator of future performance.

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