As November drew to a close all eyes were on the new strain of Covid. Global markets are likely to remain volatile until more is known about Omicron and vaccine efficacy. The Australian share market ended the month weaker as did the $AUD versus $USD. All other major indexes ended the month in the black (in AUD terms). As we look forward to 2022 the key issues remain inflation and interest rates. When will inflation come down and when will interest rates go up. We expect a slower pace of global growth for 2022 in developed economies. The liquidity peak has passed, and we are now entering a period where the excess liquidity will start to be withdrawn and with it the distortions on interest rates and risk assets in general.

 

Fed Chair Powell ditches “transitory” and flags a faster taper decision at its December meeting, but much will depend on Omicron. A faster taper could clear the way for US rate hikes starting mid next year. November jobs data showing another sharp drop in unemployment added support to the case for a faster taper. However, the Fed meeting is still a week away and much will depend on what we learn about Omicron between now and then. If it turns out to result in more severe cases against which existing vaccines are far less effective, then a decision on a faster taper will likely be pushed into next year. But even with a faster taper and three Fed rate hikes next year we will still be a long way from tight US monetary policy and the ECB, BoJ and RBA are lagging the Fed.

 

So far, the 5% or so pull back in share markets just looks like a normal correction after markets had become overbought again. Historically share market seasonality turns more decisively positive in December, particularly from mid-December. Of 22 cases of negative Novembers in the US share market since 1950, 19 were followed by gains. 

 

US data was mostly strong over the last week. While consumer confidence fell the ISM business conditions indexes rose and are very high, pending home sales and home prices continuing to rise solidly. Although payrolls rose a less than expected 210,000 in November and participation rose suggesting workers are returning, on balance the jobs data was strong with household employment up 1.1 million, hours worked up 0.5% and unemployment down to 4.2% which may be considered close to “maximum employment”. As a result, the Fed is likely to regard it as supportive of the case to speed up its taper this month and three rate hikes are likely next year, Omicron permitting. Of course, much will depend on Omicron as noted above.

 

Australia GDP fell less than expected in the September quarter and looks to be recovering rapidly. There is good reason to expect strong growth through next year of around 5.5% YoY: the savings rate has rebounded to 20% and there is now roughly $250 billion (or 13% of GDP) in excess savings built up through the pandemic which will spur future consumer spending. Business confidence is high and investment plans point to 15 to 20% growth in business investment and some pre-election government spending is likely to add to fiscal stimulus through next year. This in turn is likely to lead to a tighter jobs market and higher wages growth than the RBA is expecting through next year resulting in the start of rate hikes around November. The main threat would be if Omicron turns out to be more deadly than Delta with vaccines offering little protection resulting in a return to lengthy lockdowns, or people cutting back on their mobility anyway out of fear, until new vaccines come along and are distributed resulting in another year of disrupted growth.

 

Shares remain vulnerable to further short-term weakness given the rebound in coronavirus cases globally and the new Omicron variant, the inflation scare, less dovish central banks, the US debt ceiling, and the slowing Chinese economy. However, we are now coming into a stronger period seasonally for shares and the combination of solid global growth and earnings, vaccines hopefully still allowing a more sustained reopening and still low interest rates augurs well for shares over the next 12 months. However, continuing inflation and interest rate concerns will likely result in rougher and more constrained gains than what we’ve seen since March last year.

 

After rising by around 22% this year Australian home price gains are likely to slow to around 5% next year as poor affordability, rising fixed rates, higher interest rate serviceability buffers, reduced home buyer incentives and rising listings impact. Ultimately giving way to a 5-10% price fall in 2023.

 

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