Volatility is king: Markets brace for more turbulence amid meltdown

Veteran fund manager Matt Williams doesn’t mince his words when describing the bumpy road facing investors as the era of ultra-cheap money comes to an end.

Amid wild market swings, the portfolio manager at Airlie Funds Management says the world has moved into a period of high inflation, rising interest rates, supply chain shocks, and an energy crisis. Navigating through these powerful forces won’t be easy.

Global markets are in freefall as challenges build.Credit: AP

“We now have an absolutely new paradigm, and this massive crunch occurring all at once. So it’s a very, very tricky period for investors, consumers and companies,” says Williams who was previously the head stockpicker at Perpetual.

“The last 10 years of easy money and low inflation - we’ve reversed course, and that’s going to make for a very... choppy period.”

The comments underline the deep-seated challenges that have rattled investors lately, leading to a sea of red on global sharemarkets.

This week the ASX200 suffered its worst daily fall since the start of the pandemic and entered a “correction”, while Wall Street entered a “bear market” with a fall of more than 20 per cent from a recent high.

The trigger for these dramatic plunges was further evidence that the highest inflation in decades has not yet slowed. US inflation hit a new 40-year high of 8.6 per cent last week, while RBA governor Philip Lowe has warned Australian inflation would hit 7 per cent by the end of this year.

Central banks have made it clear they will respond by stamping down hard, evidenced by the US Federal Reserve’s 0.75 percentage point increase in interest rates, its biggest increase since 1994. Lowe took the unusual step of appearing on ABC’s 7:30 on Tuesday to tell viewers he would do “what’s necessary” to get inflation back between 2 and 3 per cent. The comments were seen as “hawkish,” and prompted Goldman Sachs economists to predict the cash rate would hit 3.1 per cent by the end of this year.

The big worry for investors is that doing “what’s necessary” could lead to a nasty economic hangover. There’s a fear that in their efforts to stamp out inflation, central bankers may end up slowing economic activity so much that they also throw the world into recession.

‘Major adjustment’

Inflation fears are hardly new: they’ve been brewing for more than a year. What’s changed is that investors now believe inflation has become entrenched, which will lead to steeper rises in interest rates, and more economic pain.

RBA governor Philip Lowe expects inflation to hit 7 per cent by the end of the year..Credit: Louie Douvis

Late last year, many including central bankers argued inflation was “transitory,” while Lowe repeatedly said he would be “patient” in waiting to raise interest rates until it was clear wage growth was above 3 per cent. These days, words like “transitory” and “patient” no longer appear in central bankers’ carefully-phrased remarks.

Central bankers now accept they underestimated inflation, which has been made worse by Russia’s invasion of Ukraine and the associated jump in energy and food prices. Other trends have added to the uncertainty, including a move towards “deglobalisation,” rising geopolitical tension, and ongoing supply chain disruptions caused by China’s “COVID zero” approach.

This array of risks has rattled investors, and the risk of a global recession now looms as a major concern.

Managing director of Sage Capital, Sean Fenton, also puts the odds of a recession in Australia over the next couple of years as “very high,” pointing to households’ high indebtedness and sensitivity to rising interest rates.

“I think what’s really shocked markets is that history shows you don’t get inflation back under control without getting some slack back into the labour market, which is a nice way of saying recession,” Fenton says.

Will Curtayne, portfolio manager at Milford Asset Management, says he believes markets are realising that inflation probably won’t be brought under control in the next few months.

“I think this is a major adjustment. We are transitioning from 12 years of low inflation, and central banks could pump monetary stimulus any time the sharemarket wobbles, to a time of high inflation where they cannot loosen monetary policy to prop asset markets back up,” he says.

Curtayne thinks there are probably more falls to come, given the high equity and property market valuations, though he is more upbeat over a longer timeframe. “On a three to six month view, we think there’s more pain to come,” he says.

Jun Bei Liu, portfolio manager at Tribeca Investment Partners, says it would take some signs of inflation was being tamed for markets to stabilise. “I think the volatility may still remain for a little bit, mainly because the market is still going through a phase where we’re not sure how far the interest rate will increase,” she says.

‘Not all doom and gloom’

Importantly, the economic outlook is not all bad. Lowe was at pains to this week point out that households are sitting on a cushion of about $250 billion in excess savings from the pandemic, and consumers continue to add to their savings piles.

National Australia Bank this week raised its prediction for the cash rate to 2.3 per cent by the end of the year, but argued the economy would slow, not go backwards. “Ultimately, we see a ‘soft landing’ for Australia with the impact of supply constraints unwinding while wage growth reaches a sustainable limit,” NAB said.

“Ultimately, the goal for most people is to weather the storm as best you can. These are not market conditions to try to get rich quickly.”

Milford Asset Management’s Will Curtayne

ANZ Bank economists Felicity Emmett and Catherine Birch said despite the economic challenges, the unemployment rate would continue falling to the “low 3s” by the end of this year, from 3.9 per cent currently. “The labour market is the bedrock of the economy – if most people who want a job have one or are able to find one reasonably quickly, it’s hard to see a drastic deterioration in the economy,” they said.

Lower income workers will also get some relief from July, when the minimum wage will increase by 5.2 per cent or $40 a week - though businesses footing the bill will face an increase in their costs.

Airlie’s Williams adds that corporate balance sheets are also in generally good shape, and believes parts of the retail sector could show better-than-expected results in the full-year earnings season in August.

“Buying the dip” in the current investing climate is a risky strategy.Credit: Peter Braig

“It’s not all doom and gloom and I think because of that, you’re going to see some pretty strong rallies in markets as things get a bit oversold,” Williams says.

Winners and losers

If the experts are right and the investing backdrop really is moving to a “new paradigm,” what parts of the stockmarket might provide better returns?

Commodity stocks such as mining and energy companies are seen as a good bet in times of high inflation, because fund mangers say raw material prices tend to rise when inflation is high.

Insurers are another popular pick, as insurance companies’ investment portfolios should make stronger returns from a sharp recovery in bond yields from the rock-bottom levels of recent years.

Some also think “defensive” sectors such as supermarkets and health care businesses should be fairly resilient to an economic downturn.

The most obvious losers, in contrast, have been “growth” stocks, especially loss-making technology businesses that relied on the equity market for funding.

These stockpickers’ rules of thumb are far from perfect, however.

Only weeks ago, many analysts said banks would be among the big winners from rising interest rates and inflation, yet big bank shares have tumbled in the recent sell-off.

At the time of writing National Australia Bank, ANZ Bank, Commonwealth Bank and Westpac were all down by well over 10 per cent in the last month amid fears of a rise in bad debts. Some investors, such as White Funds Management’s Angus Gluskie, think the sell-off in banks is overdone. “We suspect that the sell-off in the banks is a little too premature,” he says.

Perhaps the one thing investors can agree on is that we are not returning to a world of near zero interest rates, and that winding back policies of ultra-cheap money will continue to have a big impact.

In an environment like this, Milford Asset Management’s Curtayne argues the strategy of “buying the dip” - jumping into the market after a big fall in the hope of getting a bargain - is “broken.”

“Ultimately, the goal for most people is to weather the storm as best you can. These are not market conditions to try to get rich quickly,” he says.

with Simone Fox Koob

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