While developments so far this year have given investors significant cause for concern, experts are urging them to exercise patience.
Outlining the bull case for shares in a recent ASX Investor Update, BetaShares chief economist David Bassanese acknowledged the risks posed by persistent high inflation, potential escalations in the Russia-Ukraine war, climate change, and China’s property bubble and COVID-19 lockdowns.
He warned that while “a lot can still go wrong for the equity market”, “it’s precisely when stocks are in the doldrums and few can see anything positive ahead that markets are often prone to turning the corner”.
“If all or at least most of the negative fears referred to above ease somewhat, stocks are potentially poised to rebound, in BetaShares’ opinion,” Mr Bassanese said.
“In BetaShares’ view, there’s also a reasonable chance that global inflation soon begins to surprise on the downside in much the same way it surprised on the upside over the past year. Global supply chain bottlenecks are easing, as is the initial surge in demand for goods and services following the removal of COVID-19-related restrictions. Ample fiscal and monetary support during the depth of the COVID crisis is also being wound back,” he continued.
“Importantly, long-term inflation expectations remain fairly contained in most countries, and heightened global competition should lessen the risk of a repeat of the 1970s wage-price spiral, in BetaShares’ view. As and when inflation eases, central banks will also likely stop raising interest rates and may even cut them to support economic growth.”
For Australia’s part, Mr Bassanese said, the RBA may not need to push the economy into recession to get inflation under control given several important factors, including still fairly modest nationwide wages growth.
“Indeed, due to high debt levels and the sensitivity of the economy to interest rates, the RBA may not need to raise rates all that much further to get the slowdown in economic growth and inflation pressures that it desires, in BetaShares’ view,” said Mr Bassanese.
“All up, while some dark clouds continue to hang over the market outlook, there’s still a reasonable chance the skies could clear in coming months, in BetaShares’ view. And at worst, hopefully all Australian shares might face is a passing shower.”
Case for bear market
Meanwhile, in a bear case overview for the ASX, InvestSMART head of research and portfolio management, Nathan Bell, said bear case for Australian stocks is best understood by analysing the market’s biggest sectors.
“The iron ore majors constitute more than 20 per cent of the index (based on S&P data of the S&P/ASX 200 index). The iron ore price has been falling as China’s property market struggles,” Mr Bell said.
According to his research, Australia’s largest iron-ore stocks will continue to pay attractive dividends. But with some companies flagging major new investments, dividends could fall, in the Intelligent Investor’s view, particularly if a global recession hurts commodity prices.
“Depending on your definition, Australia’s banks and other finance companies constitute roughly another 20 per cent of the major indexes. Typically, higher interest rates increase bank profit margins, as they increase borrowing rates immediately but slowly increase savings rates,” Mr Bell said.
However, he warned that the current cycle may be different, with bank profit margins said to be under more pressure while technology and staff costs are increasing.
“The banks haven’t been the dream cocktail of capital gains and increasing dividends for nearly a decade now. Returns from some banks are below long-term averages despite a house price and lending boom, according to Intelligent Investor research,” he said.
“Should bad debts increasing during a recession as credit demand falls, Australian banks could potentially suffer share price falls, as they are amongst the highest valued banks in the world, according to Intelligent Investor research. Australian banks are also highly leveraged to Australia’s residential property market, which reacts to higher interest rates like it’s kryptonite.”
Mr Bell noted that the same applies for property stocks, which are also around 20 per cent of the S&P/ASX 200 Index.
“In Intelligent Investor’s view, Australian Real Estate Investment Trusts (A-REITs) have typically been amongst the more reliable stocks on the Australian sharemarket over time. However, trends such as working from home and online shopping are exposing surplus property space and pressuring rents.”
Overall, Mr Bell explained that valuations across the share market are still factoring in strong growth and are far from depressed, and suggested that investors should be patient and choose wisely.
“The reality is, many companies in the S&P/ASX 200 index are much larger than they used to be, so we can’t expect them to grow as fast anymore, particularly when their costs are under attack, in the Intelligent Investor’s view,” he concluded.
