February was mixed for markets and quite volatile with the ASX 200 up 2.1% whilst International shares MSCI World (Au) was down by -5.5%.

From their bull market highs last year or early this year US shares and global shares are down 11%, European shares are down 17% and Japanese shares are down 18%. Reflecting the strength in commodity prices, strong dividend payments and maybe a less hawkish central bank Australian shares have held up better and are down by around 7.5%. The strength in commodity prices also explains why the $A has risen since the war started whereas normally it falls in crises. 

The ongoing threat to global growth and inflation from the war in Ukraine and uncertainty as to how far the conflict will escalate will likely continue to drive huge volatility in investment markets with a high risk of more downside for a while yet.

The bulk of the threat to global inflation and growth is coming through the energy shock with various countries led by the US now banning Russian energy imports.

As we have been noting though in the last few weeks, no one knows for sure how this will unfold. But the history of crisis events and associated share market falls tells us that after an initial hit there should be a decent rebound over 6 to 12 months.

Given the stagflationary implications of the war and the financial stability risks posed by a likely Russian default on its debt and investors offloading Russian financial assets all at once, central banks continue to face a very challenging environment. So far they seem to be seeing it as more of a threat to inflation than growth. This was evident with the ECB surprisingly hawkish in the past week seeing still robust growth but much higher inflation and so accelerating the tapering of its bond buying, flagging an end to QE in the September quarter and signaling an openness to rate hikes this year. Central banks in energy producing countries will give even more weight to the impact on inflation – as we saw the Bank of Canada proceeded with a rate hike a week ago and the Fed is likely to raise rates in the week ahead, after US inflation rose to a new 40 year high in February with a further lift in median inflation indicating that the rise in inflation is broad based.

Even the RBA seems to be getting closer to a rate hike. RBA Governor Lowe reiterated that it can and will be “patient” in assessing whether inflation will be sustained in the target range (partly because inflation pressure is lower in Australia – see the last chart). But his comments in the past week were progressively more hawkish than they have been - noting now that its “plausible” the cash rate will be increased later this year and that its “prudent to plan” for a hike, alluding to the risk of sustained supply shocks boosting inflation expectations and stressing that the RBA will respond as needed to maintain low and stable inflation. 

In the US, the focus will be on the Fed (Wednesday) which is set to start the long-flagged process of raising interest rates with a 0.25% hike in the Fed Funds rate taking it to a range of 0.25-0.5%. This is widely expected with Fed Chair Powell indicating he is likely to propose a 0.25% hike and not the 0.5% some had talked about prior to the war with Ukraine. It will be couched in terms of the need to start normalizing rates to control inflation now that the economy has recovered.

Shares are likely to see continued volatility this year as the Ukraine crisis continues to unfold and inflation, monetary tightening, the US mid-term elections and geopolitical tensions with China and maybe Iran impact. However, we still see shares providing upper single digit returns this year as global recovery continues, profit growth slows but remains solid and interest rates rise but not too onerous levels.

Still very low yields & a capital loss from a rise in yields are likely to again result in negative returns from bonds this year.

Australian home price gains are likely to slow further with prices falling later in the year as poor affordability, rising mortgage rates, reduced home buyer incentives and rising listings impact. Expect a 10 to 15% top to bottom fall in prices from later this year into 2023-24 but large variation between regions. Sydney and Melbourne prices may have already peaked.

Cash and bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.1%.

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. 

Source: AMP Capital, Pendal Group, AZ Sestante