The bounce back in shares continued over the past few weeks, on hopes that slowing growth will see central banks ease up on the pace of monetary tightening helped along by mostly good earnings results, despite stronger than expected US and European inflation data. 

 

Last week the US recorded its second successive quarter of negative GDP growth, leading to discussion of the vagaries of a technical recession. June quarter GDP was -0.9%, which was lower than expectations following the -1.6% contraction in March. While two negative quarters is typically seen as the key recession indicator, in the US, the National Bureau of Economic Research is the arbiter of whether the US economy is in recession and may take months to reach this verdict. Equity markets reacted very positively to the Feds shift from forward guidance to data dependency.

 

Shares have had a good rebound from their June lows, but we remain of the view that they are still at high risk of further falls: the rally since the June lows has been lacking in conviction; we need to see clearer signs that inflation has peaked such that central banks can slow and then stop raising rates; uncertainty remains high regarding how badly economic activity will be hit; and the period out to September/October is often weak for shares, particularly when their trend is already down. On a 6-12-month horizon we remain optimistic on shares as inflation recedes, central banks become less hawkish and a deep recession is likely to be avoided, but there is a way to go yet.

 

The International Monetary Fund (IMF) downgraded the global growth outlook again and increased its inflation forecasts citing monetary tightening, China lockdowns and spill-over from the war in Ukraine, the IMF cut its global growth forecasts again to 3.2% for 2022 and to 2.9% for 2023. While it’s not forecasting a recession, it notes that the risks are tilted to the downside. It also revised its rich country inflation forecast up to 6.6% for this year and to 3.3% for next year.

 

Another rise in inflation in Australia to 6.1% for the June quarter kept the RBA on track for another 0.5% rate hike but it wasn’t high enough to justify another step up in the pace of tightening to 0.75%. The CPI increase was slightly below market expectations. Nevertheless, inflation is still going up.

 

56% of US S&P 500 companies have now reported June quarter earnings, with so far 73% ahead of expectations and earnings growth expectations for the quarter moving up from 5% YoY to 6.7% (and on track for around 9% based on the current rate of earnings surprise.) Outlook comments have been mixed, reflecting the uncertainty regarding the growth outlook. Earnings growth outside the US has actually been stronger.

 

The Federal Treasurer’s statement on the economic outlook provided few surprises, with economic growth revised down (but still a long way from recession) and inflation revised up to a peak of 7.75% in December and not expected to fall to target until 2024. This is similar to what markets have been assuming.

 

Shares remain at high risk of further falls in the months ahead as central banks continue to tighten to combat high inflation, the war in Ukraine continues and uncertainty about recession remains high. 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 policy brakes.

 

With bond yields looking like they have peaked for now, short-term bond returns should improve.

 

Australian home prices are expected to fall 15 to 20% into the second half of next year as poor affordability and rising mortgage rates impact. Sydney and Melbourne prices are already falling aggressively, and falls are spreading to other cities.

 

Cash and bank deposit returns remain low, but are improving as the RBA cash rate increases flow through.