As I ‘put pen to paper’ (the former expression for what is known now as ‘tapping the computer keyboard’), the old Tears for Fears song, ‘Mad World’ came on the radio in the background. What a very appropriate song to describe what seems to be going on in the world, er, the mad, mad world at present! And the persistent rains outside my office, propelled by the strong southerly winds, do their own mass tapping on the windows in front of my desk, creating its own added madness!

Ten months ago, as the world was well winning the battle against Covid-19, things were looking much brighter ahead. However, some of the consequences and now realities of the previous two years of Covid troubles that were simmering, were evidently coming to the fore.

The world was immersed in very cheap cash, record low interest rates, and aggressive government spending and handouts to combat Covid-19 induced global lockdowns and life adjustments. No one seemed to complain about these actions and remedies! At the start of this calendar year, the world was ready to emerge from its long moth cocooned Covid-19 stage to its anticipated bright butterfly future.  

Yet, as the curtain came up and this year unfolded, it may better be described as a false dawn! Sluggish global supply lines and logistical constraints became more obvious and inflicting. Increased demand caused by people and businesses wanting to spend but needing to pay up higher and higher prices for goods, services, and staff. The massive boom in online shopping and deliveries to our homes has also very notably spurred on this habitual spending.

To the problem: inflation had two ignitions at the same time sending it well higher than anticipated: shortage of supply and excessive demand. Not a good mix, but it is seen as being more temporary than entrenched.

Rising global inflation rates were further added to by the China zero-Covid lockdown policies and thereby creating the underutilised but much needed seaports for trade; and, also, by Putin and his posse of failed generals trying their maniacal bullying approach and threats to world peace and European energy supplies. I can’t believe psychopathic Putin running an empire of fear and death is still here.

The severity of weather conditions both in Australia and in many other countries has also caused delays and supply issues. All these variables have had an extraordinary accumulation effect on inflation. Seemingly, what could go wrong in this regard has done so. As we have seen, for all, and for the markets of all asset classes it has been a challenging 2022.

The cavalry of the central banks of the globe came with their fire hydrant technique of swiftly raising interest rates to cool the inflationary heat. And these rate rises, along with the uncertainty of possibly future rises, furthered with the somewhat confusing rhetoric on rates from the US Fed has been causing much of the market volatility in the more recent months. But rate rises are starting to take effect, but it will take time to work through.

Keeping all in perspective though, the overall level of rate increases is merely putting them nearer to historical normality but still, to date, below long-term averages. It was interesting to see the RBA pull back on the size of the rises with its one done last week being only 25bps not the markets expected 50bps. After six straight rate rises, it is prudent to somewhat pause to allow the rate rise medicine to do its job!

Dr Shane Oliver, Chief Economist at AMP, points out in his latest ‘Economics and Markets’ report that “The RBA sensibly dropped back to a 0.25% hike this month taking the cash rate to 2.60%. It is still signalling more hikes ahead though…. Slowing the pace of rate hikes makes sense: the RBA needs to allow time to assess the impact of rate hikes so far given that they impact with a lag; many households will see a sharp rise in mortgage payments which will depress spending through next year; global inflationary pressures are easing; (and importantly) inflation pressures are less in Australia than elsewhere; and there is now a higher risk of global recession which will impact Australia… We see another 0.25% rate hike next month taking the cash rate to 2.85% which we still expect will be the peak in the cash rate, albeit the risk is on the upside to 3.10%. (However) we still see rates falling late next year.”

The Senior Portfolio Manager for the Fidelity Australian Equities Fund, Paul Taylor, outlined in his October post that,” The August reporting season saw some strong results. Going forward, the market will be more focused on interest rates, the prospect of an economic slowdown and maybe even a recession in 2023 (because of the degree of rate rises). With interest rates expected to keep rising, the likelihood that the US and Europe will enter a recession in early 2023 is increasing, but it is less certain if Australia will follow suit. High energy costs coupled with better conditions for commodities will help cushion the blow to the Australian economy, but future rate rises could do some damage. An official interest rate of 4% has the potential to push mortgage rates to the 6% range, putting considerable pressure on a highly leveraged Australian consumer”.

I think this scenario of 4% interest rates here is very unlikely given we are now seeing the impact of rate hikes already doing their job to slowdown inflationary, as well as seeing the supply links improving and consumer demand reducing. The global economy is slowing down, so to have continued rate rises into next year would be very questionable economics. The markets are certainly starting to factor and price in a mild recession next year in the US and Europe, but I am not sure why so in Australia? Australia is better placed in many regards, but it is still part of the world. Nevertheless, is it a case of sell the rumour, and buy the fact, I do think so.

Taylor concludes his article by saying, “More importantly, I believe, when we talk five years from now, we’ll look back at this period of volatility and recognise it as a very attractive time (now) to have invested in markets for the long term”. And we know that investing should be and is for the long-term. We must maintain the vision for being invested in good assets.

Similarly, to both Oliver’s and Taylor’s points, Lonsec Research states in its latest News & Insights report that it “still believes that inflation will eventually peak, and we may see central banks seek to reduce rates at some point in the coming 12 months as the economy shows further signs of slowing. The global economy is already showing signs of slowing with consumer sentiment falling, certain parts of the market such as construction under increased pressure, and indicators such as PMIs, while still broadly positive, showing signs of weakening. If central banks overshoot in their rate hikes the economic slowdown will be more pronounced plunging world economies into a recession”. The RBA appears to be very aware of this by taking a very measured approach to rate rises from here.

In short, it appears that the next couple of months or so to year end, we will likely need to absorb some more market volatility, but this would appear to be lessening, and the possibility of a rate rise or possibly two more by the RBA this year, should be pretty much what we can and should expect.

With that, the rain outside has stopped, and I can see the sun is creeping through the dissipating clouds. My mind turns to a more appropriate song, which I have now just downloaded from YouTube, being ‘Walking on Sunshine’ by the boppy band, Katrina And The Waves. And it goes: ”Walking on sunshine,…..and wooah, don’t it feel good…”. 😊

Keep the faith!

As always, should you have any queries please do not hesitate to contact us.

Disclaimer for information provided in this Commentary: This document, and the contents contained within, is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, or plan feature. The views expressed in this are subject to change at any time. No forecasts are or can be guaranteed.