Why the stock market is tumbling and where it might bottom: Explainer
As recession fears grow many remain optimistic central banks will engineer a soft landing.
After a brief rebound in March, the global market selloff is picking up speed again.
Nowhere is safe. The US benchmark S&P 500 is down 15% from the peak of its short-lived rally in late March. Australian shares fell 7% over the past two weeks with falling iron ore prices removing a key buffer for the local market. Global bonds are tumbling alongside equities for the first time in decades.
Kerry Craig, global market strategist at JP Morgan, blames uncertainty on three interconnected questions:
- Is a recession brewing?
- Is inflation meaningfully slowing?
- How patiently will central banks wait for answers to either question?
“Fears of a recession have risen and linked to that is the inflation outlook and what’s happening in China and with supply chains,” says Craig. “Finally, there is the question of how central banks respond to all that.”
“Some combination of those forces are what’s driving the market on any given day at the moment as investors look for clarity about which side will win out.”
The pessimists say global economic growth is already slowing and will be crushed as central banks hike interest rates in a belated rush to rein in inflation.
But market optimists like Craig believe growth will be tough to kill thanks to cashed-up households and record low unemployment. As inflation eases of its own accord, central banks should be able to tap the interest-rate brakes instead of slamming them, the theory goes.
Below we delve into what’s worrying markets today and what signs investors should be looking for before deploying their cash.
Recession blues
Markets wringing hands over inflation are adding decelerating growth to their anxiety list.
Corporate profit margins in the US may already have peaked, according to a Thursday report from forecaster Oxford Economics. Global manufacturing activity is expansionary but decelerating. The yield curve, an indicator scrutinised for clues about future growth, is suggesting slower growth.
Bears believe we are late in the economic cycle. In other words, that the global economy is nearing a downturn and higher interest rates could be the shove that tips it over.
But Craig sees positive signs among in consumers, whose spending makes up roughly two-thirds of growth in developed economies. Today’s record-low unemployment and strong spending are “pillars of the economy”, he says.
Unemployment in Australia is projected to hit a 50-year low later this year. Data on Tuesday showed retail trading volume continued to grow, hitting a record high in the March quarter.
Where could it go wrong? Investors should watch for any “cracks in the consumer story”, says Craig. Cutting back on big purchases is often a "flashing light" of a slowdown.
One such light started blinking this week. A tracker of consumer intentions to buy major household items fell to the lowest level since the pandemic first broke out, according to Westpac-Melbourne Institute data.
Where is inflation going?
As inflation notches records around the world, investors are uncertain about how quickly price pressures will fade.
Optimists were dealt a blow on Wednesday after the pace of US inflation fell less than expected in April. The 8.3% annual increase is down from March’s 8.5% reading but higher than the 8.1% rise expected by economists. Commentators pointed to the ominous rise in the price of services after months of inflation being dominated by supply-constrained goods.
Local traders are likely to be concerned, given many argue Australian inflation will follow where the US leads.
Acknowledging the numbers fell short of expectations, Morningstar chief economist Preston Caldwell said it was “a sign things may be improving”.
He highlights the US 5-Year breakeven inflation rate, an indicator of the average inflation rate traders expect in the next five year. Falling steadily through May, it hit 2.89% on Thursday.
Shane Oliver, chief economist at AMP Capital also sees signs of a peak. The AMP Pipeline Inflation Indicator, which tracks commodity prices, shipping costs and producer prices, is flatlining amid falling freight costs and lower energy prices.
“This could enable central banks to slow the pace of tightening later this year—in time to avoid recession,” he says.
Others are less sanguine. China's zero covid policy is further snarling supply chains with hundreds of cargo ship lying anchored off the country's major ports. Disruptions from Russia's invasion of Ukraine are also spilling over beyond energy markets.
Hawks or doves?
It will be months before a clearer picture of growth and inflation appears. In the meantime, central banks are moving and markets are on edge speculating about how they will react as new data trickles in this year.
After taking a “wait and see” approach for much of 2021, central banks are making up for lost time. US Federal Reserve Chairman Jerome Powell warned on Thursday taming inflation will cause “some pain”. Earlier this month, Reserve Bank Governor Philip Lowe all but promised multiple rate hikes this year.
Bears interpret the renewed vigour as evidence central banks will prioritise inflation over economic growth, tipping the economy into recession. In this view, central banks are channelling the gung-ho inflation-fighting spirit of the 1970s and 80s.
Morningstar’s Warnes believes the bears are in control and markets have further to fall.
“I don’t like being bearish, I’m just being a realist,” he says. “There’s no use painting a picture for optimism if every colour in the palette is dark.” US markets falling another 10% to 15% “wouldn’t surprise me at all,” he adds.
However, optimists abound, especially when talking about the ASX. Ausbil founder and chief investment officer Paul Xiradis believes Australian corporates will deliver punchy profit growth through next year.
Simona Mocuta, chief economist at State Street Global Advisors, speculates an overly aggressive approach to rate hikes will be walked back.
“We can’t help but feel some nervousness around what may turn out to be excessively aggressive market pricing for rate hikes,” she says in a note. As demand and inflation softens later in the year, it may provide an opportunity for central banks to slow rate hikes.
Is there worse to come?
A lot of value has been created by the recent selling pressures, says Craig. If recession fears prove overblown and central banks pause for breath, equities will remain attractive, buoyed by strong corporate earnings.
What signals should investors watch for signs of a change in the winds? “No one rings a bell” says Warnes, but a resolution to any of the crises rocking markets would be positive.
“So many issues are hitting markets now. When there’s just one, you get more certainty,” he says.
“You can’t be putting money in the market without confidence. It’s not Dusty Springfield territory. It’s not wishing and hoping.