- A month of elevated market volatility
- US Fed plans dominate market sentiment
- Stronger growth in US economy but a moderating outlook
- Moderate conditions in Australian economy but a likely bring forward of rate rises by the RBA
The Big Picture
This time last year there was much optimism around the world. Biden had replaced Trump in the White House; vaccines were being rolled out; and China’s economy was on a tear.
For many of us 2022 has started with travel disruptions and holiday plans changed or shelved. For investors there were some heart-thumping gyrations on equity markets. Some mega-cap tech stocks in the US taking a big tumble.
But as we peer through this haze of uncertainty, we see a calmer 2022 and cause for some muted optimism. The Omicron variant of COVID-19 seems to be far less likely to cause serious illness and death than Delta and its predecessors. The vaccination programme went very well (in the end!) and more than a third of Australians have already had their boosters. Of course, there may be new strains on the horizon to cause concern but we seem to have the pandemic under better control than we did in 2021.
A lot of the market volatility was arguably caused by speculation concerning what the US Federal Reserve (the “Fed”) would do with monetary policy at its January meeting and beyond.
The short version is that the Fed announced nothing that most finance professionals did not expect. Rate hikes will start in March as the “QE” bond purchasing programme ends. The Fed is quite relaxed about how it will deal with the $9 trillion debt now accumulated over recent times. It will let some bonds “run off” as their terms expire in an orderly fashion. There is no set schedule and the Fed seems to be in control.
On the matter of the number of rate hikes in 2022, the market largely expects at least three though there is speculation that it could be as high as six. The Fed seems to be going along with that view. Although to laypeople this might seem like a big scary rate hike sequence, the fact is not. Under the worst case of six hikes in 2022, the Fed funds rate will still be well under its “neutral” rate of 2.5%. That is, monetary policy will still be very loose as we go into 2023. This is not about tightening monetary policy; it is about making it less accommodating.
The Fed funds rate was 2.5% in late 2019 just before the pandemic struck. It is now 0.0% to 0.25%. With six hikes in 2022 the Fed funds rate will be just under 1.75%. On the growth side, US Q4 2021 economic growth (GDP) just came in at a massive 6.9% against an expected 5.5%. The consumption component was well above 3%. The latest US unemployment rate is 3.9%. The US can easily handle a gradual return to normal monetary and fiscal conditions. Indeed, not to start this journey would be irresponsible and likely cause problems in the future.
At home, our economy is not quite as strong – largely due to our big shutdown in the second half of 2021 and a late response to the call for vaccinations (admittedly hampered by poor government decision making). Our latest unemployment rate is 4.2% compared to an expected 4.5%. There are, however, complications due to international travel restrictions for some workers. Perhaps 4.2% overstates the true strength of our labour market but it’s not bad (it was not less than 5% in any month from 2012 to 2019, inclusive).
On the inflation front, we just got a great result but it wasn’t met with as much enthusiasm from the press as it deserved. A Sydney Morning Herald story referred to it as “inflation surging”. In actual fact, the Reserve Bank of Australia’s (“RBA”) preferred measure – the so-called “trimmed mean” was 2.6% – right in the middle of the RBA’s target range of 2% to 3%.
The RBA has been struggling for a very long time waiting for a return to the range from persistently low inflation. Nevertheless, the eminent economist from Westpac, Bill Evans, was the first well-known economist to call (just before the inflation print) for a tiny hike in August to 0.25% followed by a full 0.25% hike a few months later. Others have now joined that party. Bill is often right and we respect his analysis.
At the December board meeting, the RBA omitted the long-held position that the first hike probably wouldn’t be until 2024 – so people interpreted that change as rates are more likely to start to rise in late 2023. The Australian economy could easily follow Bill Evans’ rate scenario but at this point there is little need for a higher official cash rate. The RBA did not meet in January.
On top of the standard data, federal Treasurer Josh Frydenberg alerted us to the fact that Australian households have saved up $260 billion during the pandemic which they could release into the economy at any time! Of course, they need something to spend it on – like ‘safe’ bars and restaurants, holidays and RATs. Households might continue to be a little cautious as there is the looming prospect of higher interest rates, including for mortgages, later in the year but there is mounting pressure to start to spend more.
We think some Australian economic data in the first half of 2022 Australian might be a bit soft at times but we are cautiously optimistic about the second half. There is a welcome growth in cooperation between the states and the federal government over vaccinations, border restrictions and public health policies. This better cooperation may also be aided by the Federal election to be held in the first half of the year
China is a bit of a worry though! Its economic data have softened of late as it tries to hang on to its ‘zero COVID’ policy. The People’s Bank of China (“PBoC) did cut rates this month as others looked to raise them. China’s exports and imports each grew around 20% and its inflation was soft at 1.5%. China is still coming to terms with its problems in the property sector. We see this as a possible low point before China builds up a head of steam. However, its latest GDP growth number was an impressive 8.1%.
When we turn our attention to companies’ views of 2022 the picture is a bit mixed. The US Q4 reporting season which is just coming to a close threw up some great results and some definite misses. For a change, some of the big banks did not do so well but some tech stocks did really quite badly. In particular, pandemic darlings, Netflix and Peloton, had their share prices slashed on weaker prospects. Indeed, there is a widespread revaluation of mega-cap tech stocks. Companies with high valuations need to continue to grow rapidly to hold on to their lofty P/E (price/earnings) ratios. Higher interest rates and moderate growth pulls the rug from under their valuations.
The 2021 second half company reports are just getting under way in Australia. What we will be looking for are statements about how they are going to deal with the Omicron fallout. Nevertheless, our detailed analysis of broker forecasts of company dividends and earnings in Australia and the US have improved throughout January. That adds comfort for our view that we could have slightly above average returns in 2022 for each market – after the January volatility has subsided.
The ASX 200, like most major markets, experienced unusually high volatility during January and particularly within the day. The market was down 6.4% on the month. The intra-daily range was often well above 1%. Many factors possibly contributed to this volatility including lower trading volumes.
The Energy sector performed well on the back of an oil price surge of over 15% but our IT sector lost nearly 20% in line with global trends.
There has been reported a large inflow of funds into broad based ETFs here and overseas suggesting some investors are ‘buying the dips’ and supporting the base.
It is always difficult to pick the bottom of any market. However, we believe the market is not expensive and earnings expectations could lead to a rebound once the volatility has subsided.
Except for London’s FTSE index, most major equities markets and the world index suffered major losses during January. The reporting season in the US, which is near its end, does appear to have been somewhat weaker than those of 2021 – particularly in the mega-cap tech sector. This was to be expected as the recovery matures.
Like with the ASX 200 we see a reasonable upward trend after the volatility subsides. The fundamentals outside of tech look favourable. ‘Catching a falling knife’ as in buying in volatile times before a bottom has reasonably been determined is ill-advised for most investors. However, we do have the S&P 500 as a whole being relatively attractive even after an extremely promising two-day rally to close off January.
Bonds and Interest Rates
The Fed all but confirmed a rate hike at the next meeting in March with three to five more to follow this year. The bond-purchasing programme is set to end – also in March. The Fed is in no rush to deal with its inflated balance sheet debt of $9 trillion – but it flagged it is plotting a course. The Fed will likely let some bonds ‘run off’ after their terms expire and in a controlled fashion.
The market is pushing the RBA to act on rates but we see little need for such a policy in Australia just yet. We are lagging behind the US and the UK in coming to terms with the pandemic. If the RBA does act this year, we think it will be a gentle response – at least at first – to test the water. The RBA is not known for swift policy action in either direction.
The PBoC cuts its reference rate in an attempt to assist its struggling economy. Its latest growth rate was a healthy 8.1% but the prospect for softer growth is lurking in the wings.
Bond yields in the US and Australia have lifted across the term structure. However, we do not see enough movement to make bonds attractive compared to equities any time soon.
There were big double digit growth rates in the prices of oil and iron ore during January. The price of iron ore rose to nearly $150 / tonne after spending a good part of late 2021 well under $100.
The Australian dollar fell by 3.4% during the same period. Gold, however, was unexpectedly flat, losing 1.4% in January.
With an election looming and the economy not in its most robust state, neither major party is likely to want to rock the boat on the run in. There will be, at least, promised stimulus on the way. Of course, it is one thing to promise and another to get a policy voted in by both Houses.
Our jobs data, on the face of it, were promising. There were 64,800 new jobs created in the latest month (December 2021) when only 45,500 were expected.
The unemployment rate fell from 4.5% to 4.2%. While 4.2% would ordinarily be considered to be classified as full employment there are so many factors such as the pandemic and international travel to make it harder to interpret. It was August 2008 when we last had a lower unemployment rate!
Our inflation rate, on the other hand, was unequivocally good. The headline rate was 3.5% but the RBA’s preferred ‘trimmed mean’ estimate that strips out more volatile items was 2.6%.
We do not have the 4%, 6% and 8% inflation rates that plague other major countries. We, therefore, do not need to follow their lead on monetary policy. We can go our own way.
There is much anecdotal evidence that bars and restaurants in Australia are operating at well below even COVID-era capacity. But, as more of the population gets their COVID vaccination booster, perhaps clients will return and spend those hard-saved ($260 bn) dollars from the lockdowns.
The economy might be a little slow at the start of 2022 but we reasonably expect growth to pick up during the remainder of the year.
China’s economic data are largely at the weaker end of expectations. GDP growth at 8.1% is certainly strong but some of this figure is due to measuring GDP from a lower pandemic base.
The Winter Olympics, like the Summer Olympics in Tokyo, are struggling to make a fist of it. On top of all of the COVID issues, hesitancy on the part of some to take part due to humanitarian issues is likely to cast a shadow on the overall success of the games.
China has largely dealt with the fallout from the property sector debt issues. Indeed, it has started to stimulate the economy with a rate cut.
The US jobs data only recorded 199,000 jobs (for December 2021) when 422,000 had been expected. These data are subject to statistical aberrations and there has been a recent tendency for the jobs data to be scaled up in subsequent revisions. Some wage growth – at around 4% – is starting to emerge. The Q4 growth was very strong at 6.9%.
Some of the GDP growth was due to movement in inventories which might not be expected to continue. However, the consumer segment was unequivocally strong at above 3%. However, the latest retail sales growth of 1.9% did not support that view and raises some concerns for the near term.
Biden is not doing well in the polls and he struggles to get his bills through Congress. Nevertheless, some much-needed fiscal stimulus is getting through. The half-Senate elections are approaching in November, so both parties might be trying to attract the spotlight in these next few months.
Boris Johnson has been caught out for attending parties during lockdowns. He seems to be brushing the commotion aside. Importantly, the UK is opening up to overseas visitors without vaccinations. Djokovic has a possible berth at Wimbledon!
Russia appears to be on the edge of conflict in the Ukraine. Biden let it slip that he would allow a ‘small incursion’ but not an invasion by Russia. Sometimes it is better to say nothing.
We are not in a position to shed any light on the likelihood of conflict, let alone US involvement. Obviously, any action in that part of the world is likely to spill over into more market volatility. There is too much at stake for either side to be silly. Putin is looking to a ‘president for life’ job. Would sabre rattling help? Possibly, but war might be a bridge too far.
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