Randal Jenneke, head of Australian equity at T. Rowe Price, said that political tensions and stubbornly high inflation are driving tough conditions and there are more rate hikes on the horizon.
“At the halfway point in 2023, global labour-market conditions remain tight while the inflation outlook remains quite challenging, more challenging than markets are prepared to acknowledge, in our view,” Mr Jenneke said.
“Whilst headline CPI may have peaked and started to reduce from elevated levels, it remains uncomfortably high for central banks. Core inflation, which is what matters most to central banks, has remained sticky. Progress in taming inflation has been slow due to strong services price inflation that in turn has fed through to higher wages.
“Our view remains that Australia is a long way from interest rate cuts, and there indeed may be a few more rate hikes to come.”
Mr Jenneke said that despite this outlook and a forecast of a “mild recession” to bring down inflation, “much worse economic scenarios than this", similar to 2008 or 2020, "are not on our radar”.
He added that global spillovers have proved manageable and the “economic outlook for Australia for the next six to 12 months is one of subdued growth but no recession”.
“In terms of economic activity, the RBA has only made a modest downward adjustment to its 2023 growth forecast. Whereas in February, it projected 1.5 per cent growth in real GDP, in May this was lowered to 1.25 per cent,” Mr Jenneke said.
“Still, low positive economic growth is not such a bad result given Australia’s high beta to world trade. [The years] 2023-24 is projected by the IMF to be the weakest two-year stretch for global growth in over 20 years.”
China’s reopening, he said, looks to be little more than “false hope” for both the global economy and more specifically, Australia, as a resources exporter.
“China’s initial rebound has been concentrated on consumer services like travel, hotels, and restaurants. The rebound in manufacturing has been weak, reflected in shrinking import demand,” Mr Jenneke said.
“Based on the latest monthly PMIs, the reopening boost to the Chinese economy appears to be fading.
“So far, there is no sign that Beijing is prepared to unleash significant fiscal stimulus in order to boost domestic demand, since the government’s 5 per cent GDP growth target for 2023 remains a relatively low bar to beat.
“However, if April’s disappointing data for residential property and construction is repeated in May, Beijing may yet buckle and introduce more meaningful fiscal stimulus. In the short-term, this should be positive for the price of iron ore, for resources stocks, and for the Australian dollar.”
Looking at inflation, Mr Jenneke believes that while it has likely peaked, there is no clear marker of how high interest rates need to rise to bring inflation back to central bank targets.
“The resilience to date in economic activity and employment is creating a bigger risk of a nastier downturn by potentially forcing major central banks to be more aggressive than market expectations. The collateral damage from rising rates will be corporate earnings, which are expected to be downgraded going forward,” he said.
“It is likely any policy error will be one of overtightening causing a recession. Whether or not we have an economic recession in Australia, it is highly likely we will have an earnings recession as economies slow. So far, analysts have not adapted to this reality, as earnings revision ratios have recently increased in all major regions, while the flattish EPS forecasts for CY2023 are not compatible with even mild recession.”
Mr Jenneke added that growing wage pressure in Australia brings into question whether the RBA will be able to meet its inflation target without further hikes in the cash rate.
“While the RBA’s 25 basis points rate increase in June to 4.1 per cent was seen by many as the last hike in the cycle, we think more needs to be done,” he said.
“Australia’s central bank has been very clear on its objectives — the need to reduce inflation remains paramount, with services price inflation in particular too high for comfort. Service sector inflation rose in Q1 2023 compared to Q4 2022. The RBA’s forecast for CPI inflation in CY2023 of 4.5 per cent is far above its longer four-term forecast of 3.0 per cent by mid-2025.
“There is a risk of Australia lagging behind the US in terms of its disinflation trend because of domestic wage pressures. The annual CPI inflation of 7.8 per cent in Q4 2022 was a 30-year high, falling to 7.0 per cent in Q1 2023.”
While economic conditions are tough the world over, Mr Jenneke concluded that Australia is in a better spot than many.
“Australia is relatively well-positioned for the new global investment regime that is unfolding, with many good, long-term investment opportunities,” he said.
“In the short term, however, we advise caution toward the more expensive high P/E names, to banks that face rising bad debts, and to businesses generally that are vulnerable to a cyclical slowdown. For now, we prefer to own quality defensive companies with lower earnings risk and more stable profit margins.”
