ANZ has warned that a recession is still likely to occur later in 2023 despite the positive performance of equity markets during the second quarter of the year.
In a quarter-end investment update, Lakshman Anantakrishnan, head of investment strategy, private banking and advice at ANZ, argued that the longer the late cycle phase drags on and the higher central banks need to raise rates, the deeper any potential market fallout may be.
“In our view, it appears a few key factors have simply delayed, rather than stopped, any eventual downturn — one we still expect before year-end. Rather, our recent message to investors remains — don’t confuse late with not coming,” he said.
Addressing the positive returns seen in equity markets in recent times, Mr Anantakrishnan pointed out that, while solid, they had been characterised by “rather idiosyncratic features”.
“Over the first half of the year, the S&P 500 rallied more than 16 per cent. However, remove the performance of the top seven contributing stocks and this performance looks drastically different — somewhere closer to 5 per cent,” he noted.
“And although the recent earnings season came and went — without deeply negative revisions — it was the second successive quarter of negative earnings growth, with a third expected to follow.”
Mr Anantakrishnan said abundant liquidity, including the liquidity backstop provided by the US Federal Reserve in response to the banking crises earlier this year, had likely been a “prevailing force” for equities over the first half of 2023.
“Indeed, this may help explain why — even with the Fed’s ongoing balance sheet reduction — equity markets have remained buoyant. And while there’s been some divergence of late, there is a clear correlation between equity market performance and market liquidity,” he said.
“However, with the US Treasury now refilling its general account — and the Federal Reserve set to continue its balance sheet run-off over coming months — we expect liquidity to evaporate and this divergence to converge once more as liquidity becomes a drag on asset prices.”
A combination of tighter financial conditions, negative earnings growth, and restrictive monetary policy settings are unlikely to bode well for risk assets, according to Mr Anantakrishnan.
While the slower pace of the economic downturn was not anticipated by ANZ, Mr Anantakrishnan said the overall direction was in line with its expectations. Additionally, he noted the performance of some equity markets had left the bank “pleasantly surprised”.
“However, we would caution against becoming too aggressive and chasing a market that has rallied more than 20 per cent since its October low and almost 100 per cent from its COVID nadir, particularly when financial conditions remain so vulnerable,” he added.
“While the outlook for equities appears more troublesome, sound investment opportunities remain and bonds, in particular, are providing important diversification benefits to portfolios and compelling yields once more.”
But Mr Anantakrishnan also acknowledged that markets rarely behave as expected, with significant downturns typically followed by sharp upswings as seen over the pandemic period.
“Attempts to time investing to maximise returns during these periods is typically a fool’s errand, often leaving investors disappointed,” he warned.
“Being invested in a well-diversified portfolio that is ready to take advantage of opportunities on the other side of any downturn is often the best course of action. Remaining invested through the full market cycle is the most critical factor for compounding returns and long-term wealth creation.”
