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Market and Economic Commentary | End April 2022

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Paul Zwi's picture
Analyst: Paul Zwi, Portfolio Strategist, Clime Asset Management

Share markets ended April weaker. The ASX200 Accumulation Index fell by -0.9%. European markets also declined, with the German DAX down -2.2%. In the US, the major indexes likewise fell, with the S&P 500 lower by –8.7%, the Nasdaq by –13.2%, and the Dow Jones by –4.8%. With greater uncertainty keeping markets nervous, the VIX volatility index rose to 33.4 by month end. So-called “safe haven” assets such as gold were mostly off their highs, whilst US Treasuries rose sharply in yield and were lower in price, continuing their descent over the last few months. The Australian dollar fell over the course of the month.

Mid-April, the World Bank cut its global growth forecast for 2022 from 4.1% to 3.2% highlighting two factors leading to lower global growth expectations:

  • the damage done by Russia’s invasion of Ukraine
  • surges in food and energy prices

The World Bank expected Europe and central Asia to be the regions hardest hit. The IMF added to this by warning countries that substantial amounts of private debt accumulated during the pandemic by companies and low-income households were likely to significantly slow the recovery in the years ahead. It singled out China as an area of risk.

Adjustments in growth expectations come at a difficult time. Just as increasing vaccinations offered hope that the pandemic was finally ending, the war in Ukraine disrupted global economic recovery. One of the most visible effects has been the acceleration of food and fertiliser prices. Triggering concerns about food shortages and increasing the risks of malnutrition and social unrest. According to the UN’s Food and Agriculture Organization, world food prices surged by 33% in March from a year earlier.

The COVID-19 pandemic has played an ongoing role in curbing growth over the last two years. Economies around the world have incurred massive debt burdens from extraordinary fiscal actions in response to the pandemic which lead to a surge in debt and deficits in 2020 and 2021. Global public debt is expected to fall in 2022 and then stabilise at about 95% of gross domestic product over the medium term, 11% higher than before the pandemic. Large inflation surprises in 2021 helped reduce debt ratios, but as monetary policy tightens to curb inflation, sovereign borrowing costs will rise, narrowing the scope for government spending and increasing debt vulnerabilities.

Governments are under pressure to deal with these new risks to public finances in the form of rising energy and food prices. To alleviate the burden on households, ensure food security, and pre-empt social unrest, many governments have announced measures to limit the rise in domestic prices. In Australia, we have seen this with the Government cutting the petrol and diesel excise levy by 22 cents per litre for six months. Such actions could have large fiscal costs and exacerbate global demand and supply mismatches.

Partly in response to the latest pandemic lockdowns, the IMF cut its 2022 growth forecast for China from 4.8% to 4.4% in its latest outlook. Noting momentum was pointing to weakness ahead. Pandemic lockdowns, the Ukraine war, energy prices, and ongoing issues within the property sector are continuing to build downward momentum on the Chinese economy.

Current COVID-19 lockdowns have come at a precarious moment for China’s economy, following shortly after the debt crisis in its real estate sector. The government has targeted growth of 5.5% in 2022, which would be its lowest annual rate in three decades, however it is looking unlikely that the target will be achieved. The country’s rapidly depreciating currency and the lockdowns spreading from city to city are raising fears of a Chinese shock to global growth. Complicating matters is that China is now in a very different place in the monetary cycle from the US, Europe, and Australia, and is involved in easing credit. Australia’s economy remains uniquely intertwined with China. Indeed, China remains Australia’s largest two-way trading partner in goods and services, accounting for 30% of our trade with the world.

In positive news, the IMF upgraded Australia's growth outlook for 2022 GDP growth from 4.1% to 4.2%. However, supply shocks caused by the Ukraine war prompted the IMF to raise its CPI estimate to 3.9%, well outside the Reserve Bank of Australia's (RBA) 2-3% target and sharply up from the estimate in January.

The consumer price index (CPI) inflation rate increased to 5.1% in the March 2022 quarter, above consensus expectations. The Morrison Government's Pre Election Economic and Fiscal Outlook (PEFO) noted the outlook has not materially changed since the March Federal Budget. Deficit and debt forecasts were unchanged, the outlook for Australia's economy remains strong, with the unemployment rate still expected to fall to 3.75% in the third quarter. GDP continues to benefit from high iron ore prices.

It is hard to see any significant implications for Australian financial markets emanating from the upcoming Federal election. Labor is not offering a significantly different economic policy agenda than the Coalition. With the exception of climate policies, we do not anticipate a significant impact on investment markets from a change in government. The bigger risk would come from a hung parliament, where a minority government would be forced into relying on minor parties or independents for support.

On balance, the global economic recovery from the pandemic will continue, but at a slower pace. With inflation rising – Australia's consumer price index (CPI) rate increased to 5.1% in the March 2022 quarter, above consensus expectations – at a time of slowing growth, the risks of central banks raising rates higher and faster than markets anticipate are a growing concern. The Fed and other Central Banks will have a difficult balancing act to perform this year. The risk is that if rates are increased too quickly or by too much, recession vulnerabilities might emerge either later this year or next.

Assets that are vulnerable in an environment of rising rates include those with weak cash flows or profits, high balance sheet leverage or funding issues, and those securities with overly expensive valuations. While the outlook for highly priced growth assets is challenging, solid businesses that benefit from inflation and moderate economic growth will continue to do well. Similarly, premium real estate will continue to provide attractive returns.

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