The Month in Review - Oct 2022
Monthly Review
Farrow Hughes Mulcahy Investment Research 08 November 2022
Markets rebounded in October reversing some of the losses of the previous month. The ASX 200 was up 6% and the MSCI World in US$ was up 7%.
During the month Fed Chair Jerome Powell’s hawkish tone, after the Fed’s 75bp rate hike, weighed on markets. Though signs that Beijing may be getting ready to roll back zero-Covid by March helped markets. In Australia the RBA reinforced its more dovish rate path, choosing to take a risk on inflation to avoid triggering a damaging recession.
The medium-term outlook still depends on the degree of economic downturn and its impact on earnings. There is some debate about the degree of leverage earnings will have in the downturn. Historically, recessions have led to an average 20 per cent fall in earnings. Though this is often in a low-inflation environment, when nominal GDP (a proxy for corporate revenue) is low.
In this instance the bulls argue that three factors may mitigate earnings decline:
1.Companies will benefit from higher nominal growth, supporting revenue and helping cover fixed costs
2.Materials and energy companies will see continued strong earnings, given lack of supply
3.The potential re-opening of China may offset weakness in Europe and the US
This degree of earnings leverage remains to be seen. But it’s fair to say we are in a different type of cycle than those investors have grown used to.
In the US all wage data series are rolling over, but growth is still too high at around 5%. It needs to fall to 4%. Earlier in the week we saw job-opening data reverse the previous month’s decline. A range of indicators show the labour market softening and lay-offs picking up. But the data is still too strong for the Fed to feel comfortable on inflation.
Finally, manufacturing data (the ISM index) weakened more than expected, though not enough to indicate a recession.
In Australia as expected, the RBA raised rates 25bp to 2.85% last week. The message remains far more benign than the Fed. The RBA expects rates to peak at 3.5%, versus 5% to 5.25% in the US. Inflation is expected to peak at 8% this quarter and fall to 4.7% a year later, with GDP slowing to 1.4% in 2023.
The risk is inflation does not drop so quickly, given this level of growth.
Shares remain at high risk of further falls in the short-term as central banks continue to tighten, 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 brakes.
With bond yields likely at or close to peaking for now, short-term bond returns should improve.
Australian home prices are expected to fall 15% to 25% top to bottom to the September quarter next year, as poor affordability & rising mortgage rates impact. (This assumes the cash rate tops out between 3% to 4%)
Cash and bank deposit returns remain low but are improving as RBA cash rate increases flow through.
Sources : Pendal, AZ Sestante, AMP Capital Investors.
Important note: While every care has been taken in the preparation of this document, Farrow Hughes Mulcahy make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.
