After strong gains, shares are potentially heading towards a pull back or more volatile returns than seen so far this year.
“The bull market since the 2022 lows has been driven by optimism that inflation is falling, enabling central banks to lower interest rates at the same time that economic growth has held up better than feared, resulting in a sort of Goldilocks – not too hot and not too cold – scenario. But after such strong gains, there is now a significant worry list for shares,” AMP’s Shane Oliver said in a recent note.
Of particular concern for Oliver are Iran’s attack on Israel, stretched valuations, uncertainty over rate cuts, the US presidential election, and the still present risk of recession.
“The combination of stretched valuations, high levels of investor optimism and technically overbought conditions leave shares potentially vulnerable to a further pull back. Geopolitical risks including events in the Middle East, delays to rate cuts, and recession risks could provide a trigger,” the chief economist said.
However, he highlighted several considerations which suggest that the bull market will remain intact despite the vulnerabilities.
“First, US, global shares and Australian shares are still tracing out a pattern of rising lows and highs from 2022, which is still consistent with a bull market,” Oliver said.
“Similarly, we have yet to see the sort of churning and a declining trend in the proportion of stocks making new highs that normally comes at major share market tops. And while many worry about a new tech bubble (and have done for years), the tech and AI centric stocks of today make real profits so Nasdaq’s PE is around 35 times, not the 100 times plus it was at the tech bubble high in 2000.”
Second, Oliver judged that despite areas of weakness, global and Australian economic conditions remain “better than feared”, as do profits.
“Third, despite the relative resilience of economic activity, inflation has fallen sharply globally and will likely keep falling, allowing rate cuts,” the economist said.
While the US has proven “a bit stickier”, inflation has continued to fall in other countries. As such, Oliver said rate cuts are “still likely” despite being delayed.
“Fourth, while Chinese economic growth is not as strong as it used to be, it seems to be hanging in there around 5 per cent despite its property slump,” the economist explained, adding that while the price of iron ore has fallen, it remains in the same range as it’s been for the last two or so years.
Finally, Oliver said, while geopolitical risks are high, they may not turn out to be “as bad as feared”.
“While the risk of an escalation between Israel and Iran is high – Iran’s retaliation to the attack on its Syrian consulate was similar to its response when General Soleimani was killed by the US in in 2020. It was well flagged, measured, and there was minimal damage and designed not to provoke a bigger Israeli counter-retaliation.
“The US is also pressuring Israel to hold back and, of course, is motivated by trying to keep oil prices down in an election year. So far so good so markets have not gone into freefall and the oil price has not surged. Hopefully, that remains the case, but there is a way to go yet.”
As such, Oliver remains of the view that shares will “do okay” this year.
“But given the long worry list, global and Australian shares are vulnerable to a correction or at least a more volatile and constrained ride than seen so far this year,” he cautioned.
“For most investors though, the key is to recognise that share market pullbacks are healthy and normal, it is very hard to time market moves and the best way to grow wealth is to adopt an appropriate long-term investment strategy and stick to it.”
