But have the markets advanced at a pace that surpasses macroeconomic conditions or are we on the verge of a sustained recovery in the second half of 2023, continuing the trend of a positive first half, 2023 investment performance? We believe there are five crucial themes that will significantly impact the trajectory of financial markets in the upcoming six months.
1. The probability of a mild recession to minimise the negative impact of markets
The probability of a domestic recession over the next 12 months remains evenly poised at around 50 per cent, while in the US, it is higher at 64 per cent, slightly off its peak of 67 per cent in January 2023. However, while the outlook for global growth is expected to be constrained through the second half of 2023, we believe any recession at this stage will be “mild” in nature, and as such, will not be as destabilising for markets, in the advent of a longer lasting, deeper slowdown. Our rationale for this is the strength of labour market. With the jobless rate in Australia (as well as the US) at multi-decade lows and showing few signs of any rapid deterioration, we view this as an important marker to the ability of the economy to withstand a further slowdown in economic activity and to mitigate a broad market sell-off, despite expectations of a further moderation in the earnings outlook for corporate Australia.
2. Inflation remains sticky and well above target levels
While inflationary pressures have moderated through the first half of 2023, they remain well above central bank target levels of 2.0 per cent to 3.0 per cent and have shown few signs of a rapid decline, despite the aggressive moves by global central banks since the first quarter of 2022. The stickiness of inflationary pressures across multiple parts of the economy (i.e. utility prices, construction costs and rent, food and beverage, transport, fuel and recreation) and the associated pressure on wages further complicates the inflationary outlook. Should inflation not move back towards central bank target levels, the case for higher for longer cash rates will remain.
3. Cash rates close to their peak
Given the inflationary backdrop, we anticipate an increase of up to 50 basis points in domestic cash rates over the next six months, with a likely terminal rate in 4.50–4.75 per cent range. This upward trend will continue to exert pressure on sectors that are more sensitive to interest rates, such as consumer discretionary retail, which may continue to affect the sector’s short-term performance.
While we expect cash rates to continue rising in the latter half of 2023, one positive aspect is that rates, both domestically and globally, are nearing their peak. As inflationary pressures have shown signs of moderating, central banks are no longer strictly following an auto-pilot approach to raising rates. This flexibility allows central banks to adjust their policies accordingly. With the projected peak rates expected to be reached in the second half of 2023, it sets the stage for a potential decrease in cash rates in 2024 should inflationary pressures continue to ease, setting the foundation from which markets can advance.
4. China remains pivotal for a turnaround. Outlook for emerging markets positive
Despite the move of increased onshoring and a shift by countries to seek multiple supply chain sources, as the second largest economy and “factory to the world”, China remains pivotal for world growth and the performance of key commodity markets. While China enjoyed a solid start at the beginning of 2023, economic activity has slowed materially through Q2 2023.
A rebound in the growth outlook for China will be a positive catalyst for financial markets while allowing for global growth to achieve a more stable footing. With the US economy being the bellwether economy through H1 2023, the need for further policy initiatives by both the Chinese government as well as the PBOC to support a recovery through H2 2023 will alleviate some risks associated with any material slowdown in the US. We continue to expect that the Chinese RMB will move lower through the second half of 2023 (against the US dollar). In our view, this will be supportive for Chinese trade exports while also reducing cost (inflationary) pressures in other regions.
5. We see bond investments providing an attractive investment opportunity
Despite the negative impact that higher cash rates and rising bond yields have had on parts of the financial market, it has resulted in improving valuations across the fixed income sector. With bond yields now close to or back above 4.0 per cent, bonds are once again providing a ballast to multi-asset investment portfolios. Improving valuations across bond markets have increased the diversity of investment opportunities for investors from duration to spread-based investments. The ability for investors to balance exposures between growth and income assets in our view will lead to improved and more consistent investment outcomes through 2024. With the potential for cash rates to move lower in 2024, we see bond investments providing an attractive investment opportunity that can comfortably sit alongside growth assets in a portfolio.
ASX moderately higher by December
In terms of where we see the ASX 200 Index at the end of 2023, based on current market valuations and using our forward P/E and the forward dividend yield assumptions for the market, we expect it to be only moderately higher (around +1.5 per cent to 2.0 per cent) from its current levels. However, over the medium term (2024–25) we do see earnings being upgraded, which should lead to an improved outlook for the market.
Piers Bolger, CIO, Infinity Asset Management
