Soft landing? | BetaShares

Soft landing?

BY David Bassanese | 7 February 2022

Global markets

Here is the critical question of the year: can the Fed engineer a ‘soft landing’ for the U.S. economy?

In other words, can it slow the economy by enough to take the pressure off red-hot wage and price inflation without causing the economy to tip into recession, or at least suffer a significant enough downturn that corporate earnings growth also weakens in line with the existing interest-rate driven downward pressure on equity valuations. Provided earnings hold up, and it’s only a valuation de-rating that takes place, then the U.S. equity market correction should be contained to no more than 15-20% (at its recent low, the S&P 500 has already corrected by 10%). If not, a peak-to-trough drop of at least 20-30% could still be ahead of us.

Global stocks bounced back for a second week reflecting oversold conditions and broadly heartening news on the corporate earnings front. Although Meta slumped on much weaker than expected earnings, Alphabet, Amazon and Apple all enjoyed blowout results. All up, U.S. earnings in the latest reporting season are once again holding up well, as might be expected given the strong economy and evident pricing power being displayed. But markets rightly remain focused on the interest rate consequences of this growth, with U.S. 10-year bond yields pushing higher last week to 1.91%.

Not helping the interest rate outlook, the Bank of England hiked rates for the second successive time last week and even the ultra-dovish European Central Bank suggested it might need to lift interest rates by year-end. Friday’s U.S. payrolls report was also much stronger than expected, with the biggest concern a further burst in wage inflation – with annual growth in average hourly earnings accelerating to 5.7% from 5.2%. Russia-Ukraine tensions also continue to push up oil prices. U.S. markets now attach a 50% chance to a 0.5% rate increase at the March Federal Reserve meeting – to my mind, this is possible though still not probable.

The U.S. earnings season rolls on this week with likely still positive results from the likes of Disney, Nvidia and Coca-Cola. The highlight, however, will be Friday’s U.S. consumer price index report, with annual inflation expected to lift further to 7.3% from 7.0%. Core annual inflation (i.e. excluding food and energy) is expected to lift to 5.9% from 5.5%.

Among global equity themes, there was a (likely brief) pause in the rotation towards value from growth and towards defensive from cyclical stocks last week.

Australian markets

Local stocks bounced in line with global stocks last week, supported by still dovish signals from the Reserve Bank of Australia – though overall our market has broadly tracked global performance in recent months. Retail sales dropped in December, reflecting renewed COVID concerns – though this did not stop ongoing strong demand for housing loans. House prices rose further in January, though the monthly pace of gains continues to slow.

The bottom line from the deluge of RBA information last week is that it’s still patiently waiting for a decent acceleration in wage growth before it lifts rates, though it’s more open-minded that conditions might be in place by year-end, instead of some time in 2023.

In large part, the market and many economists still think the RBA will hike by August, or November at the latest. I’m less sure, though I’m prepared to change my mind if a range of wage indicators suggest a speedier lift in wage inflation than I anticipate. I think the RBA still wants to give the economy the best chance of a decent drop in unemployment, thereby helping spread the benefits of lower interest rates more broadly – from not just asset owners to wager earners. If I’m right, near-term rate hike expectations should ease back further and the $A may well head to my target of US 68c.

This week key data highlights are the NAB and Westpac measures of business and consumer sentiment on Tuesday and Wednesday respectively – neither of which are expected to be market-moving.

All up, the three key financial market targets I have for H1’22 are: the $A at US68c, US 10-year bond yields at 2.25%, and the forward-PE ratio for the S&P 500 down to around 18 from 20.

Have a great week!

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