Meanwhile, the risk of recession remains high, with the continuing rise in oil prices adding to the risk of recession. Uncertainty remains high around the Chinese economy, there is increasing uncertainty about the US economy & fiscal policy and the period into mid-October is often seasonally weak for shares. All of which leaves shares vulnerable at a time when US valuations are looking very stretched and will become even more so if bond yields keep rising. While valuations for the Australian share market are more attractive it would likely follow any further correction in US shares in the short term.

 

The trend remains down in Australian inflation, but inflation is still too high. The good news is that all of the rebound in inflation in August was due to a 9.1% rise in auto fuel prices which added 0.3% to inflation. Underlying measures of inflation were either flat or down. The RBA held rates at 4.1% as expected. There was little change to their statement under Gov Bullock and the RBA continues to see data as consistent with inflation returning to target in 2025.  The RBA reiterated its tightening bias “that some further tightening of monetary policy may be required” and the risk of another rate hike by year end has gone up.

 

Despite more negative headlines in the property sector pertaining to Evergrande and a depressed stock market, China sentiment improved moderately. PMI activity indices announced in the week improved, indicating the worst of activity data could now be behind us. The iron ore price remains stubbornly high despite depressed property. China’s industrial profits rebounded sharply surging 17.2%, which was the first monthly growth since the second half of last year. Additionally, industrial production picked up and producer-price index (PPI) eased to 3% year-on-year. Profit declines from consumer goods manufacturing narrowed in the first seven months amid measures to expand domestic demand, while other types of industries also saw an overall improvement in earnings. The upbeat data is another sign that China’s growth momentum is bottoming out after a slew of supportive measures, although persistent weakness in the property sector remains a drag.

 

The next 12 months are likely to see a further easing in inflation pressure 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 near-term shares are at high risk of a further correction given high recession and earnings risks, the risk of higher for longer rates from central banks, rising bond yields which have led to poor valuations and poor seasonality into 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.

 

With an increasing supply shortfall, our base case remains that home prices have bottomed with more gains likely next year as the RBA starts to cut rates. However, uncertainty around this is high given the lagged impact of interest rate hikes and the likelihood of higher unemployment.

 

Cash and bank deposits are expected to provide returns of around 4-5%, reflecting the back up in interest rates.

 

The $A is at risk of more downside in the short term on the back of a less hawkish RBA and weak growth in China, but a rising trend is likely over the next 12 months, reflecting a downtrend in the overvalued $US and the Fed moving to cut rates.