The Australian share market and broader economy have navigated some difficult moments recently but now face multiple threats that could upset end-of-year trading.
The incoming challenges include the delayed impact on consumers of the fast-rising rate cycle and the prospect that borrowing rates will stay higher for longer to combat stubborn inflation.
In other words, the era of cheap money may not return any time soon, hurting the ability of households and businesses to borrow and expand, and making it harder for governments to service debts.
There are also the large cracks in China’s property sector, and anticipated diminished need for construction materials such as Australia’s iron ore, as well as rising oil prices, and any global fallout from the political divide in the US over debt levels.
Each individual threat may be contained, but together, the damage could be substantial.
Luke McMillan, head of research at Ophir Asset Management, said recent volatility in equity markets showed investors were uneasy.
“The precursor to that was higher for longer interest rates – they’re like gravity for equity market valuations,” McMillan said.
“You certainly do run the risk when you go through these rate tightening cycles, and then credit tightening, that you find something breaks.”
While forecasts differ, many economists predict there is a strong chance the US, Australia and the UK will all fall into recession in the coming months.
Fears over a recession
There has been heightened investor fear ever since the yield curve inverted in October 2022, a classic signal that a recession was incoming in the US. The yield curve also recently inverted in Australia.
The curve reflects an expectation that interest rates will decline over the longer term, which is associated with an economic pullback.
But during the months that followed the US inversion, many economies – including Australia – fared better than expected on the back of strong job markets and resilient consumer spending.
Debate then turned to whether central bankers could orchestrate a “soft landing” for their economies, perhaps gentle enough to avoid a recession.
Global share markets were also buoyed up by a rally in AI technology stocks, led by chip maker Nvidia, which arguably masked some of the issues emerging in other parts of the market.
Some of that optimistic sentiment has started to unwind in recent weeks as the cost of capital increases, with bond yields pushing towards levels last seen in 2007, shortly before the global financial crisis took hold.
McMillan said while it’s important to be realistic about predictive abilities when it comes to markets, the risks are evident.
This includes the potential for a significant event that could spook investors, he said.
“We are definitely in that window where a critical event could happen from left field,” McMillan said.
“There is enough to suggest in terms of these leading indicators, which are at levels that are commensurate with a recession happening in the future, that we can’t write off that possibility yet.”
Uncertain times
After a series of rises and dips, the Australian share market is at a similar level to the start of 2022, representing neither overt confidence or pessimism.
Omkar Joshi, chief investment officer at Sydney-based Opal Capital Management, said some of the impact of the sharp lift in interest rates was still to be felt, and companies were facing potential headwinds on customer demand, revenue and profit margins.
“We’ve not been going up in any meaningful way, but not falling either. We are just stuck in sideways price action,” said Joshi.
“It feels like that’s the environment we’re in and we’re probably going to be there for a bit longer because there’s just very little clarity and certainty.”
A recent spike in oil prices due to mounting worries over a supply deficit is an emerging concern given it is lifting global inflation, prompting policymakers to consider putting more pressure on borrowers by raising interest rates.
In Australia, rising fuel prices underpinned the first jump in the consumer price index in four months when data was released on Wednesday, erasing recent progress in bringing inflation down.
To be sure, one of the reasons for the uncertain outlook is that there are still mixed signals in the market, leaving investors unsure whether they should buy or sell.
One of the main reasons interest rates have not necessarily peaked is that the US, Australia and many other national economies have so far proven resilient, underpinned by strong employment levels.
In early August, Bank of America economists scrapped their prediction for a mild US recession in favour of a “soft landing” with no recession.
John Ayoub, portfolio manager at Wilson Asset Management, said while there was still strength in the global economy, it was now suffering “multiple paper cuts”.
“I think it’s going to be a more prolonged soft landing, rather than a short, sharp recession,” he said.
“I suspect we are going to go through a longer, protracted recovery path, which is more manageable, but arguably more painful.”
