Investors hold nerve on ASX 200 but strategists warn of rocky year

Investors have poured money back into shares after a worrisome January, but leading strategists and fund managers warn of a rocky year ahead.

This is a big week for markets grappling with the prospect of ­aggressive central bank tightening to clamp down on inflation. Picture: NCA NewsWire/Jeremy Piper

Investors have held their nerve, pouring money back into shares after a worrisome start to the year.

However, leading strategists and fund managers warned of a rocky year ahead as rising inflation and a peak in the Covid-19 pandemic leads to a faster withdrawal of policy support.

After falling as much as 7 per cent in the past three weeks as US shares had their biggest fall in more than a year, Australia’s benchmark S&P/ASX 200 share index mostly recovered from a 1.2 per cent intraday fall to an eight-month low of 7086.8 points on Monday.

The index closed down 36 points, or 0.5 per cent, at 7139.5 points, with Macquarie, Goodman, Domino’s Pizza and REA Group finding strong support after recent falls as US futures pointed to a bounce in US shares after their worst week since the Covid panic of March 2020.

Regional markets were mixed, with China’s Shanghai Composite and Japan’s Nikkei 225 both up 0.2 per cent, while the Hang Seng Index fell 1.3 per cent and South Korea’s KOSPI fell 1.5 per cent.

It is a big week for markets grappling with the prospect of ­aggressive central bank tightening to clamp down on inflation, albeit China has started easing policy ­recently.

On Thursday, the Fed is expected to heighten expectations of policy tightening, testing the market valuations of growth stocks amid reports from such giants as Tesla, Microsoft and Apple.

Tuesday’s release of Australian CPI data could affect market expectations for domestic interest rates. Economists see a 1 per cent rise in quarterly headline CPI and 3.2 per cent on an annual basis.

US purchasing managers data on Wednesday will gauge the economic outlook and US GDP data will show the state of consumer demand and price pressures going into year-end.

“The markets have come down but they are still up very significantly from their March 2020 lows, whereas earnings haven’t risen anywhere near that much,” said Matt Sherwood, head of investment strategy at Perpetual.

“You might say that it could have some more to go if it was to realign with the earnings outlook. The key for investors is to know that markets don’t move in a straight line,” Mr Sherwood added.

“There is a lot of fear and risk aversion is quite elevated, but given that markets have vastly outperformed earnings, the US is at full employment with inflation more than double the official target, reinforced by wage pressures, it’s really hard to believe that’s it.”

Mr Sherwood said that for shares to stabilise, the Fed would need to wind back rate rise expectations, but such a “blink would cause more chaos in markets because it would signal that they’re really not serious about inflation”.

In a move that may reduce the amount of exposure that certain kinds of fund managers, such as risk parity funds, can have to the sharemarket, the S&P 500 VIX volatility index soared to a seven-week high near 30 per cent on Friday compared to its long-term average of 19 per cent.

 

T. Rowe Price head of Australian equities Randal Jenneke said a peak in Covid-19 may be a double-edged sword as the growth implications were offset by the prospect of stimulus withdrawal.

“The market basically thinks that this (Omicron) is the last big disruption, which means that the focus really is on normalisation, particularly when it comes to central bank policy, hence why everyone is so fixated on how the Fed gets inflation under control in the US and what it needs to do,” Mr Jenneke said.

“Clearly, the governments and central banks including the Fed way overstimulated and now they have to withdraw stimulus and normalise, and the question is how much they need to do.”

Whereas at the start of 2020 the market wasn’t contemplating US interest rate rises in 2022, it is now priced for as many as four rate increases from the Fed this year with a risk of more. Last week the US 10-year bond yield hit a two-year high of 1.9 per cent, versus 1.5 per cent at year end. “It shows you just how quickly things have shifted and that’s what’s driving a lot of the sell-off right now,” Mr Jenneke said.

“The high PE part of the market gets hit hard first, then the overall market goes down. I think the reality is demand has to slow and when demand slows, growth slows and earnings will slow. That’s why it’s a very tough year for markets.”

High PE sectors including tech, healthcare and consumer discretionary have been the worst performing S&P/ASX 200 sectors in the year to date, while energy, materials and utilities have fared best.

“If you look at the sectors that have outperformed so far this year it’s energy and materials, and I get in the short term why the market is doing that, but it’s not going to last,” Mr Jenneke said. “Those cyclical sectors will come under pressure because demand will be impacted by rising rates.”

As for when central banks such as the Fed might “blink” in response to sharemarket falls, Mr Jenneke said the world’s most powerful central bank was unlikely to do so any time soon.

While seeing potential for that, he believes it could be three to six months away and would probably involve the US sharemarket tipping into a “bear market” fall of at least 20 per cent.

“Right now, the focus isn’t on markets and it isn’t even on juicing growth, the first order issue to get inflation under control,” he said.

Originally published as Investors hold nerve on ASX 200 but strategists warn of rocky year