20 Feb Economic Market Snapshot – February 2023
I’m tired of being bearish, but…
Markets continue to be a rollercoaster for investors. We continue to take a ‘safe hands’ approach to portfolios as we roll from a positive month, to a negative month, back to a positive month and so on, with volatility proving quite challenging. Our longer-term outlook continues to be a slowing 2023 calendar year, with share markets grinding down in valuations as company earnings are tested, we have positioned portfolios accordingly.
Inflation and interest rates remain the two talking points with clients. Whilst inflation appears to be peaking here in Australia and starting to decline in other western economies, the fact remains, any inflation rate above the 2% to 3% RBA targeted range is problematic and a drag to our economy. The inflation movement down from 8% to say, 5% can occur quickly, the movement from 5% to 2% could pose further challenges. The rising interest rate cycle continues long after the inflation peak, language that the RBA Governor is now strongly building into his commentary.
In referencing the monthly volatility we are seeing, the most significant take aways from my perspective are:
- Nothing shakes an economy & investment markets like inflation;
- Economic markets are not investment market;
- Rising interest rate impact has a lagged effect.
It is not uncommon for investment markets to offer short-term rallies despite the larger economic backdrop, so it can appear at times, that economic and investment markets appear at odds with each other. Beware the “bear market rally” is a phrase often referred.
With close to 40% of home loans in Australia on a fixed rate, the RBA rate rising measures introduced since April last year have, to this point, only meaningfully impacted 60% of the home mortgage population, so spending patterns to a large extent have remained unchanged. It is against this backdrop, we have positioned our portfolios as we expect to now start seeing the impact of rising interest rates work into the economy at an increasing rate. We anticipate this starting to have significant change.
A recent article in the Australian Financial Review (AFR) in early February (just prior to the most recent 0.25% interest rate rise announcement taking the RBA rate to 3.35%), surveyed 20 leading Australian economists on two topic areas: where will interest rates peak and do we expect to see a recession? The responses ranged from interest rates have peaked with no further rate rises to come to the terminal RBA rate to reach 4.45% later this calendar year, in other words, a 1.35% spread – hardly definitive.
A similar scenario played out when addressing the issue of recession timing, with responses ranging from there will be no recession with a very soft landing and negativity already priced into share markets, to declines of another 10% to 20% from here and a recession later in 2023.
When those charting the course of the big banks and investment institutions here in Australia can offer such diverse views, it is fair to say “nobody exactly knows”, after all, it’s the markets.
With such statements in mind, client conversations usually turn to “should I sell now and go to cash?” My response – a definitive “No”.
To sell investments to cash takes a portfolio to a 100% fully convicted position that a share market correct/devaluation is imminent, a position outlined above that some of Australia’s leading economic minds can’t agree. In practice, a decision to move to cash usually occurs after a first drop in value thereby, having already absorbed in part some of the loss, the decision to re-enter investment markets driven by an established recovery in value, meaning the most astute outcome requires timing perfectly investment markets twice – a very difficult task.
The 3 critical factors in determining a plan from here:
- Is my current risk profile still an accurate reflection of investment risk tolerance?
- What is my investment timeline/horizon?
- What are my cashflow requirements from here and do I have cash in reserve to ride through?
Within our investment portfolios, we continue to be conservatively positioned across all risk tolerances:
We have increased the defensive allocations in each portfolio to hold additional cash as a defensive tilt in the event of markets falling and have reduced our exposure to growth investment managers in favour of value fund managers with a longer, stable history of delivering performances, most notably in ‘Bluechip stocks’.
Please don’t hesitate to call me.