Shares have weakened over the past few weeks. Further correction remains possible given that: the risk of recession remains high; China’s economy is still at risk; there is a risk that the disinflation process could pause in response to higher energy prices and sticky services inflation; central banks are still leaning hawkish; there is a high risk of another US Government shutdown from 1 October if US politicians fail to agree a budget or continuing resolution this month; high bond yields are still pressuring share market valuations; and the weak seasonal period for shares goes out to October. However, our 12-month view on shares remains positive as inflation is likely to continue to trend down taking pressure off central banks and any recession is likely to be mild.

 

Australian inflation fell more than expected in July enabling the RBA to keep rates on hold at its monthly meeting. From its peak of 8.4% YoY in December, the Monthly Inflation Indicator has now fallen to 4.9% YoY in July. This was less than consensus. The bad news is that inflation is still too high and several key areas are still seeing very strong and accelerating inflation – notably rents, electricity, insurance costs and higher petrol prices may boost inflation again in August. This indicates that there is a chance that rates may have peaked but are likely to stay higher for longer.

 

US economic data was mixed. Home prices continued to rise in June and personal spending rose sharply in July. The July manufacturing conditions ISM rose slightly more than expected but remains weak at 47.6, with the components for employment, new orders and prices paid all below 50. 

 

Consumer confidence unexpectedly fell in August and the sharp rise in consumer spending relative to income saw the household savings rate fall. With US excess savings built up during the pandemic now run down by around 75%, the jobs market slowing and the reopening boost behind us it’s unclear how long consumer spending on goods and services in particular can continue to remain above their pre-pandemic trends.

 

Eurozone economic data was soft, but inflation is a bit sticky. Economic confidence fell again in August and is now back to around last year’s lows and unemployment was unchanged at 6.4%. However, CPI inflation in August was unchanged at 5.3% YoY, which is down from a peak of over 10% YoY last year but higher than market expectations for a fall to 5.1% YoY. Core inflation still fell to 5.3% YoY from 5.5%. The latest inflation data poses a bit of a dilemma for the ECB, but on balance it’s likely to leave rates on hold in September as it waits for the lagged impact of rate hikes to slow growth and inflation, but the risks are high of another hike and its likely to retain a strong hawkish bias.

 

The Australian June half earnings reporting season is now a wrap. It’s been better than feared but expectations were still revised down on the back of cautious corporate guidance. Key themes from the earnings results have been that: cost pressures remain a challenge; building material companies are still benefitting from strong activity although some are warning of a slowdown; insurers are seeing margin improvement at the expense of their customers with big premium increases; so far home borrowers are keeping up their payments (but rate hikes have yet to fully flow through); and corporate guidance has been cautious with more negative than positive guidance and retailers in particular are warning of tougher conditions and better off customers turning to discount stores for bargains. Partly reflecting the cautious outlook guidance consensus earnings expectations have been revised down since the reporting season started. The consensus is now for a +1.5% rise in earnings for 2022-23 and for a -5.7% fall in earnings in 2023-24, with both revised down from +2.5% and -0.8% respectively at the end of July.

 

The outlook for investments is mixed. The next 12 months are likely to see a further easing in inflation pressures and central banks moving to get off the brakes. This should make for reasonable share market returns, provided any recession is mild. But for the next few months shares are still at risk of a further correction given high recession and earnings risks, the risk of still more hikes from central banks, rising bond yields and poor seasonality out to October.

 

Bonds are likely to provide returns above running yields, as growth and inflation slow and central banks become dovish but given the recent rebound in yields this may be delayed a few months.