Share market strength narrows odds of a short-term correction

A strong recent performance by the Australian stock market could end soon as the silly season for share price falls approaches.

The chance of a sharp fall in the stockmarket is rising after excitement around moderating inflation pushed share prices higher just before the traditional weak season for stocks.

While the ASX 200 index fell 0.7 per cent on Friday, dropping 52.3 points to 7403.60, over the past three weeks it has added 5.5 per cent.

Analysts say the market outlook has improved as fears of recession in the US and Australia subside, but there remains a high risk of a correction following a strong recent run-up.

Things could turn sour as soon as Tuesday with the Reserve Bank’s monthly board meeting potentially resulting in rate rise number 13 since May 2022, while the profit reporting season also heats up.

AMP head of investment strategy Shane Oliver said June and July had been good for markets and stocks were near their highs, so there was a “significant” risk of a pullback.

“This time of year is known for weakness,” he said.

“I’m always wary of this period of the year – it’s often a time you get corrections.

“There is obvious risk because investors have been getting more excited about a soft landing globally.”

BetaShares chief economist David Bassanese says there may be one or two more rate rises.

More bad economic news, or central banks continuing to lift interest rates, could send shares lower, Dr Oliver warned. “There is a risk that central banks go too far, and the recession risk is back on again.”

BetaShares Capital chief economist David Bassanese said there was a good chance of a 5-10 per cent correction in the short term, but there could be optimism later in the year.

“The RBA is still looking for the economy to slow, and if it doesn’t there is still the chance of one or two more rate rises,” he said.

“Our market hasn’t done as well as global markets, so we are probably not as vulnerable to a major correction.

“I think we are trapped in this broad range at the moment because there is very little earnings growth.”

Bell Direct analyst Grady Wulff said the US was edging closer to avoiding a recession and this was changing the short-term outlook.

“General consensus at the start of 2023 was that a recession was imminent in the US and markets would enter correction territory,” she said.

“Now a recession in the US is only factored in at a 20 per cent chance, down from a 75 per cent chance back in May, so this shifts the outlook to a softer landing both for economies and share markets.”

Ms Wulff said the August reporting season would be telling for the sharemarket and show investors how companies had fared in 2023’s high inflation and high interest rate conditions.

“As the ASX 200 is trading up almost 5 per cent in 2023 so far, it is likely that a pullback of some kind will be felt in the coming months, possibly after earnings season or if inflation remains sticky in the US and prompts the Fed to continue raising rates,” she said.

The Dow Jones ended a 13-day run of consecutive rises late last week, falling 0.7 per cent on Thursday, but rebounded 0.5 per cent on Friday, giving Australian shares a positive lead for Monday.

Ms Wulff said stocks at the most risk of heavy falls were those yet to turn a profit or revenue such as exploration or early-stage health companies.

“Any signs of a correction traditionally prompt investors to sell off riskier assets in favour of safer blue chips and staple sectors,” she said.

Grady Wulff from Bell Direct says a pullback of some sort is likely in the coming months.

Ms Wulff said the question of where Aussie shares would be in December “almost requires a crystal ball to answer”.

Viridian Financial chief investment officer Piers Bolger said the market may have got ahead of itself, but a soft landing remained a possibility.

“When you consider that we are also closer to the end of the rate tightening cycle, this can set the scene for a further rally across the market through the second half,” he said.

“The reporting season will be an important gauge as to the near-term direction of the market, but we are not in the camp of a severe, prolonged correction at this point in time.”

Mr Bolger said the market might be “moderately higher” by the end of the year. “However, over the medium term, 2024-25, we do see earnings being upgraded, which should lead to an improved outlook for the market,” he said.

Dr Oliver said he expected the market to rise over the next 12 months. “I suspect by the end of the year it will be up for this year, but you will probably get a correction along the way.”

Originally published as Share market strength narrows odds of a short-term correction