Market ‘staring down the barrel’ of economic downturn as stocks tumble

In its worst day since May 2020, the S&P/ASX 200 index closed down 3.6pc at 6686, as the market was ‘staring down the barrel of an economic downturn’.

Macquarie analysts say: ‘We have become increasingly concerned with the economic outlook for Australia’. Picture NCA Newswire/ Gaye Gerard.

The Australian sharemarket is “staring down the barrel of an economic downturn”, a top fund manager warned after the bourse was caught in the wake of a damaging sell-off on Wall Street.

In its worst day since May 2020, the benchmark S&P/ASX 200 share index closed down 246 points, or 3.6 per cent, at 6686 after a massive two-day fall on Wall Street.

The local bourse is now 12.4 per cent below its August peak, having entered its first “correction” of the current bull market that began with unprecedented stimulus at the start of the Covid-19 pandemic.

Tuesday’s plunge came after the S&P 500 index on Wall Street dived 6.8 per cent over Friday and Monday to be 21.8 per cent below its record high in January.

As the US market suffered from Friday’s blowout inflation data and expectations of more aggressive rate hikes, the ASX 200 dived 5.3 per cent at the open on Tuesday morning to 6566.1 – its lowest level since February 2021. It bounced as S&P 500 futures rose despite predictions of a supersized Fed rate hike this week. Goldman Sachs has predicted 75 basis point hikes in both June and July.

It came after the local bourse dived 4.2 per cent last week, its worst week in more than two years, after the Reserve Bank delivered a bigger-than-expected rate hike of 50 basis points last Tuesday.

BlackRock’s head of equities Charlie Lanchester said the Australian market in aggregate should continue to outperform because of its low exposure to large growth stocks and high exposure to resources companies which have benefited from booming commodity prices this year.

But global risk aversion and news of a fresh Covid-19 outbreak in Beijing hit the resources sector on Tuesday, with Fortescue Metals down 8.5 per cent and Woodside Energy down 5.3 per cent.

While the S&P/ASX 200 index is down 10 per cent for the year to date, with the tech sector down a massive 37 per cent and banks off 10 per cent, the energy sector is up 33 per cent and the materials sector 2 per cent as the Ukraine war and Western sanctions on Russia have caused a surge in commodity prices.

Mr Lanchester said the Australian market was “staring down the barrel of an economic downturn” and warned of continued pressure from rising bond yields.

“The interesting thing in the last couple of days is that the downdraft has started to move across the whole market and we are entering this new stage of what is clearly a bear market – the headline move doesn’t say so but many parts of the market clearly are in a bear market in Australia,” he said.

“That probably reflects people realising that rates are moving higher and faster and we can see that the bond market is predicting rates will go significantly higher in a pretty short space of time.”

The Australian 10-year bond yield rose 28 basis points to an eight-year high of 3.96 per cent.

“There will be an economic impact from that,” Mr Lanchester said. “It’s not just the fact that we have a higher discount rate (or risk free rate) to value equities, it’s also the fact that we are staring down the barrel of weaker economic growth and I think that is a big concern for Australia.

“We have a pretty effective transmission mechanism for monetary policy via variable rate mortgages. Most people have not locked in their mortgages and those that have are locked in for a reasonably short period of time, so while there are some buffers built over the last couple of years, there’s still a lot of leverage in the system, particularly around borrowing for houses, which is a big part of banking profits.”

Saxo Markets warned the local market wasn’t necessarily cheap after the sell-off as the financials, consumer discretionary and technology sectors earnings faced headwinds. The market’s
12-month forward price-to-earnings ratio fell to about 13 times versus a two decade average of about 14.7 times.

But the consensus earnings estimates used to calculate the market PE multiple may prove overly optimistic if the economy weakens amid surging inflation and interest rates.

“We actually think aggregate earnings are falling and will continue to fall, with commodities being the outlier, albeit there is concern about the resurgence of Covid-19 in Beijing, so there have been considerable falls in the commodity sector,” said Saxo strategist Jessica Amir. “The fundamentals for the market are looking very shaky right now. They’re saying that the consumer – the biggest part of the economy – is very weak.”

Even after Tuesday’s 12.4 per cent fall in the ASX 200 from its record high last August, surging 10-year bond yields are a “huge wake-up call” for investors.

“If a retiree can invest in a safe haven (10-year bonds) and get 4 per cent, why would they invest in a risky asset class like shares?”

A key difference now versus the start of the Covid pandemic is that there isn’t the possibility of great monetary and fiscal stimulus being unleashed because of inflation.

Rather, stimulus is expected to be withdrawn to clamp down on inflation. “If we don’t see enough demand destruction and inflation coming down we could see the cash rate going above 3 per cent this year and eventually 4 per cent,” Ms Amir added.

Saxo Markets predicted a further 30 per cent for the local sharemarket.