Welcome to the New Year. In January the MSCI World NR (AUD) was down -2.3%. The S&P/ASX 200 was down -6.3%.

The first three weeks of January saw hedge funds de-leveraging and the market cutting growth positions as it was considered that inflation was no longer transitory and that rate rises may be coming more quickly than expected. This phase has played out for now. The market is likely to be more focused on earnings in the near term.  The bull case from here relies on slowing growth and easing supply chain pressure resolving the inflationary pressures without requiring a significant economic slowdown. The bear case is that rates are still low, inflationary pressures are rising (oil, wages, rents, company pricing power) and the market begins to raise its view on where terminal rates are. Last week’s news flow shifts probability to the latter. We think the market’s expectations are still playing out. Hence, we remain cautious in the near term.
 
The key notion underpinning central bank thinking is the realisation that the combination of emergency policy measures, substantial fiscal expansion and supply chain disruption has triggered a significant rise in inflation — and they need to stop stimulating as quickly as possible. This means normalising rates in a shorter timeframe than previously thought. The next step would be an increase in the terminal rates they are targeting, though we are not seeing this yet.
 
US payrolls came in at +467,000 new jobs versus +125,000 expected. This strong number was reinforced by material positive revisions to recent months and resilient average earnings data. All this highlights that the Omicron wave has had limited impact on the economy and makes the Fed’s job of slowing inflationary pressures harder.
 
Data released in the US last week shows civilian worker wages are up 4% from last year. Another survey showed all private-sector wage growth of 5%, while leisure and hospitality wages were up 8.9% year-on-year.  Wage growth is critical to watch. It is the factor that can turn supply chain inflation into more structural inflation. The bottom line is that pressures driving inflation are not yet showing any signs of abating.
 
We remain of the view that monetary tightening will not be enough to end the global and Australian economic recoveries this year and that shares will remain in a rising (albeit more constrained) trend, but this does not necessarily mean the correction in shares is over. The bounce from the January low has been strong and welcome, but a bounce from very oversold levels is not that unusual. Markets will still have to grapple with uncertainty about how high interest rates will rise, particularly amidst ongoing inflationary pressures, the unwinding of excessive valuations for some tech stocks and uncertainty regarding Russia and Ukraine (and the associated threat posed to European gas prices). US mid-term election years are also known for volatility.
 
New covid case number and hospitalisations continue to fall. The BA.2 variant appears to be 30% more transmissible, but no more severe. The US has seen case numbers halve and hospitalisations fall 25%. Fatalities have fallen 80%, mostly due to immunity that has built up in the community from vaccines and prior infections. The death rate among those who have had vaccine boosters is 99% lower than the unvaccinated. The ability for health systems to largely weather the Omicron wave is likely to reduce the use of restrictions in future waves. We should now see a re-opening boost heading into the northern hemisphere spring.
 
Global shares are expected to return around 8% this year but we may now be starting to see the long-awaited rotation away from growth & tech heavy US shares to more cyclical markets. Inflation, rate hikes, the US mid-term elections and China/Russia/Iran tensions are likely to result in a far more volatile ride than 2021, and we are already seeing this.
 
Despite their rough start to the year Australian shares are likely to outperform helped by stronger economic growth than in other developed countries and leverage to the global cyclical recovery.
 
Still very low yields & a capital loss from a rise in yields are likely to again result in negative returns from bonds.
 
Unlisted commercial property may see some weakness in retail and office returns, but industrial property is likely to be strong. Unlisted infrastructure is expected to see solid returns.
 
Australian home price gains are likely to slow with prices falling later in the year as poor affordability, rising mortgage rates, higher interest rate serviceability buffers, reduced home buyer incentives and rising listings impact.
 
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