You Never get Certainty and Value at the Same Time

There is an old saying in investment markets that you never get certainty and value at the same time. Now, there is significant uncertainty, however, we have far better value. The time to be cautious was late last year, when both equity and bond markets were trading at record highs.

In the last 15 years we have had six market corrections, including two large corrections of almost 40%-50%, being the Global Financial Crisis in 2008 and the Covid-19 recession in 2020. We have also seen four smaller corrections ranging from 15% to 25% in equity markets for various reasons other than recession. The depth and length of these corrections are always difficult to predict but in time they have always presented an opportunity to buy equities cheaply and increase returns through the cycle.

                                                                                                 ASX 200 Index: 2005 -2022

Markets in 2022: Central Banks, running the risk of overcorrecting?

Markets this year have fallen sharply. Central bank policy hasn’t helped. Like a drunken driver leaving the scene of an accident, Central Banks are moving aggressively upwards with interest rate policy, fishtailing the economy as they do so. Our Reserve was late to the party and realizing they had over-stimulated the economy following the Covid-19 recession, are now  sharply tightening interest rates to bring down generational high inflation. Because Central Banks were well behind the inflation curve, they now run the risk of overcorrecting, fishtailing the vehicle (which is the Australian economy) and ending badly, i.e recession (worst case). While likely in the USA, the probability of a recession is a lesser risk in Australia, although demand will be nullified.

Cash rates are at 0.85%. Adding another 200 basis points for further tightening takes us to 2.85%. Add a margin on for the banker who lends to the borrower and we have retail lending rates at 5 to 5.5%. Business lending will have a higher margin above that.

The effects of interest rate rises will be to reduce demand for housing (slow housing construction activity) and also reduce discretionary spending given higher home loan repayments will account for most disposable income for most households. This will impact on both business and consumer confidence.

This should be tempered by the positives given we have almost full employment (unemployment rates below 4% in the both the US and Australia), strong wages growth and a high level of savings. Additionally, we do not have significant excess capacity or excess stock and inventory; in fact we have the exact opposite. For this reason, we are not expecting a recession given the conditions are different from those that preceded the Global Financial Crisis in 2008.

 

Market Moves in 2022

While we can’t accurately predict a low point, Global Equity markets have also now fallen sharply this year and we have started to, and will continue to buy the dip progressively.

Corrections in equity and credit markets are common. If you are able to buy these when they come along every few years and look through the short term noise, you will benefit in the longer term having bought assets cheaply. Remember markets look forward 9 to 12 months and price on future expectations.

Speak to one of our financial adviser