Bear market looms as party’s over for equities

Australian shares are hurtling towards a bear market that’s unlikely to be truly stopped by policy stimulus until central banks get a grip on inflation.

The S&P/ASX 200 index has dived 10.8 per cent in the past two weeks to a 19-month low of 6474.8 points. Picture NCA Newswire/ Gaye Gerard.

Australian shares are hurtling towards a bear market that’s unlikely to be truly stopped by policy stimulus until central banks get a grip on inflation.

In the meantime central banks could well cause a recession, which will be bad for shares.

A brief positive reaction to Fed chief Jay Powell’s comment that he doesn’t expect 75 basis point rate hikes – like the one he deli­vered this month – to be “common”, was followed by a damaging 3.3 per cent fall in the S&P 500 to a fresh 18-month low of 3666.77 points.

A shock 50 basis point rate hike by the Swiss National Bank was the proximate cause.

But the “risk-on, risk-off” reaction to the Fed’s June meeting looked a lot like the reaction to the May meeting, which also sparked a one-day rise after Powell also gave investors a false sense of security when he said he wasn’t considering 75bp hikes.

In the past two weeks, the S&P/ASX 200 index has dived 10.8 per cent to a 19-month low of 6474.8 points. It is deep in a “correction” of the post-Covid bull market, down about 15.1 per cent from the August peak. The S&P 500 is in a “bear market”, 23.6 per cent off its peak. The post-Covid bear market was the shortest on record, as central banks and governments unleashed unprecedented stimulus to stop Covid-19 lockdowns from causing a depression.

But there’s no possibility of stimulating now without adding to rampant inflation – caused by excessive stimulus, supply-chain disruption and commodity shortages worsened by the Ukraine war and Western sanctions on Russia – which central banks are now desperately trying to control.

The sharemarket is on its own as far as policymakers are concerned.

No doubt the fabled “Fed put” still exists at some point.

Early this month some FOMC members started talking about the possibility of a pause.

But as was the case then, such talk won’t last while inflation stays high.

The best guess of global fund managers surveyed by BofA this month was that the Fed would “pause” or “pivot” if PCE (personal consumption expenditure) inflation fell below 4 per cent, jobless claims exceeded 400,000 and the S&P 500 fell below 3500 – only 4.5 per cent lower – but only 14 per cent of respondents made the later call.

Almost 50 per cent of global fund managers in BofA’s survey nominated sub-4 per cent PCE inflation level, but the core PCE deflator is currently 4.9 per cent, although it has fallen for the past two months.

Moreover, the current situation of central banks and governments being essentially unable to bail out financial markets and the economy because of inflation is something most investors haven’t experienced. In the BofA survey, 79 per cent of fund managers expected higher rates, compared with the prior market lows in March 2020, when 53 per cent expected lower rates.

Parts of the financial markets will be safer than others, and the Australian market has some positive attributes, including less exposure to high-PE growth stocks that get hit by rising interest rates, more exposure to resources stocks that benefit from high commodity prices, and plenty of gold miners, consumer staples and others with the ability to pass on sky-high prices to consumers.

But the current situation is not something anyone should be complacent about.

The policy limitations suggest that this could be the longest bear market on record. With its market-leading 19 per cent share of Australian sharemarket flow, Swiss bank UBS has a good view of what investors are doing in response to the inflation blowout, the central bank response and the increasingly correlated fall in asset classes.

“What has really been evident this week is that the global central banks really want to get ahead of inflation and snuff it out as soon as possible,” UBS Australia head of equities Clinton Wong said.

UBS’s estimates of the required rate increases are “increasing on a weekly basis” and the supply-chain disruption “has got worse, not better in the last six months”.

“Central banks have this blunt tool – interest rates – which is trying to dampen demand,” Mr Wong added. “I’m a bit concerned that they are trying to blunt the headline CPI result, which has got a big energy component which they will not be able to blunt, so they actually have to blunt the other part of the consumer even harder, to bring the headline down. That’s why the market is selling off so hard: because the equity market is really concerned that if you do that, you will push the economies into recession.”

Mr Wong said it was a concern that long bond yields continued to surge despite central bank tightening in recent months. “Markets don’t mind rates going up, but they want to have good visibility.”