Australians under 40 often grapple with housing affordability, ongoing mortgage repayments, family planning, and career progression.

However, these are also exciting times, marked by milestones such as buying your first home, having children and career advancements.

What’s often missing are the conversations with ageing parents on the planning of wealth distribution.

With around $3.5 trillion expected to be transferred from those aged 60+ over the next 20 years – almost the size of our current super system – AMP’s recent research (with under 40s Australians) has uncovered some interesting dynamics within families – including a lack of communication between the generations on wealth matters.

Not relying on the ‘Bank of mum and dad’

The findings also reflect a clear desire of under 40s to secure their own financial independence, not relying on the ‘bank of mum and dad’, despite concerns that increasing housing unaffordability will impact their own wealth in retirement.

• 4 in 5 under 40 haven’t asked their parents for any financial support
• 3 in 5 under 40 haven’t spoken to their parents about wealth transferral
• Only 1 in 5 are relying on financial assistance and inheritance from their parents for their future financial security

Despite these statistics, half of those under 40s that were surveyed, believe they will need to financially support their parents, as they age.

In the current economic environment, intergenerational wealth discussions within families need to become a priority, as those under 40 reflected a general lack of confidence in achieving financial security and independence, despite their desire to do so.

• 3 in 5 under 40 believe their generation has it harder financially than their parents did, increasing to 7 in 10 for those under 29
• 4 in 5 under 40 who currently don’t own a property believe it will be out of reach
• 4 in 5 under 40 believe that not owning a property will be detrimental to their long-term wealth and retirement

When you consider the above findings with the knowledge that many Australian retirees are fearful their savings won’t last – a fear which prevents spending and impacts their quality of life, potentially hindering open discussions with their children – it becomes even more important that effective communication and financial planning is implemented for the benefit of all generations.

How financial advice can help

Financial advice is important, not just for pre and post retirees, it can equally help the under 40s develop successful wealth creation and protection strategies by looking at a client’s whole situation including the intergenerational wealth challenges within their extended families and devising tailored solutions for their unique circumstances.

An adviser can help younger clients engage with their maturing parents and understand the implications of different decisions with regard to intergenerational wealth transfer, including options involving financially dependent loved ones.

Contact us to see how we can help develop a wealth creation strategy to suit your goals and plans.

Current as at August 2024

Introduction

After pushing to record highs, share markets had a sizeable correction into last week – with US and global shares down nearly 9% and Australian shares down nearly 6%. Such volatility is not unusual and is the price we pay for the higher longer term returns shares provide over defensive assets like cash and bonds. However, it’s clear the source of global volatility & investor concern is now switching from worries about inflation back to growth. This note looks at seven key charts worth keeping an eye on.

Chart 1 (and 1b) – inflation

A global interest rate easing cycle is underway. It kicked off in the emerging world and spread to developed countries starting with Switzerland and Sweden and more recently Canada, the ECB and the UK. The US is likely to join in September with Australia likely to follow early next year. So far this has been driven by falls in inflation which has allowed central banks to become less restrictive. Obviously, inflation needs to continue its path to central bank targets and so still needs to be monitored. In this regard, our US Pipeline Inflation Indicator continues to point to lower inflation ahead. While US unemployment has spiked, so far other US economic indicators are mixed so an emergency inter-meeting or 0.5% cut is unlikely unless economic data or share markets fall sharply.

AMP Pipeline Inflation Indicator

Source: Bloomberg, AMP

Australian inflation is lagging the US by 3-6 months, including in terms of the recent pause in the fall in inflation. Our Australian Pipeline Inflation Indicator continues to point down though. As a result, we remain of the view that the next move by the RBA is a cut although absent an economic and/or financial shock the RBA is unlikely to be “sufficiently confident that inflation is moving sustainably towards the target” until around February next year when we expect the first rate cut.

Australia Pipeline Inflation Indicator

Source: Bloomberg, AMP

Chart 2 – longer term inflation expectations

The 1970s tells us the longer inflation stays high, the more businesses, workers and consumers expect it to stay high and then they behave in ways which perpetuate it. The good news is that short term inflation expectations have fallen sharply, and longer-term inflation expectations remain low as measured in the US by the University of Michigan. In Australia the RBA assesses that they have increased but only to around 2.5%. This is very different from 1980 when US inflation expectations were around 10% and deep recession was required to get inflation back down.

US University of Michigan Consumer Inflation Expectations

Source: Macrobond, AMP

Chart 3 – global business conditions PMIs

A key driver of how shares perform over the next 6-12 months will be whether major economies including Australia slide into recession and, if so, how deep it is. Key forward looking indicators – like the US yield curve and Leading Index and consumer confidence in Australia – suggest the risk is high reflecting rate hikes since 2022. Some good news though is that any recession may be mild as we have not seen the sort of spending excesses that often precede deep recessions. Global business conditions indexes (PMIs) – which are surveys of purchasing managers at businesses – will be a key warning indicator. Right now, they are soft but at levels consistent with okay growth, although weakness in manufacturing is a concern.

Global Composite PMI vs World GDP

Source: Bloomberg, AMP

Chart 4 – unemployment and underemployment

Jobs markets have been cooling leading to falling wages growth which is good news for rate cuts. The bad news is that if unemployment and underemployment rise too rapidly it can become self-perpetuating for a while as it leads to job insecurity, which leads to less spending, which leads to more job losses, etc. This has been particularly the case in the US over many decades and explains recent concern about the further rise in unemployment.  Of course, the recent spike in US unemployment could reverse and it’s been more due to more workers rather than permanent layoffs which makes it different to past cycles so far. And in Australia it remains low by the standards of recent decades. But the trend in both countries is up and forward-looking indicators – like hiring plans and job ads – point to a further rise.

Labour market underutilisation rates

Source: Bloomberg, AMP

Chart 5 – company profits

Consensus US and global earnings growth expectations for the next 12 months are around 13%, and in Australia they are around 5%. This would be at risk if we slide into recession. US June quarter earnings results for tech and consumer discretionary companies were more mixed but so far so good with profits up 11% on a year ago. In Australia, its early days in the June half reporting season which is a bit make or break given expectations of a return to growth after two financial years of falls. Ideally, we need to see more companies reporting increases in dividends from a year ago as this would be a sign of corporate confidence in the sales and profit outlook.

ASX 200 Companies Reporting…

Source: Bloomberg, AMP

Chart 6 – the gap between earnings and bond yields

Since 2020 lows, rising bond yields and rising price to earnings multiples have worsened share market valuations. The recent fall in share markets has seen some improvement, but the gap between earnings yields and bond yields (which is a proxy for shares’ risk premium) is still around its lowest since 2011 in Australia and 2002 in the US. This still leaves shares vulnerable to bad news.

Equity risk premium over bonds

Source: Reuters, AMP

Chart 7 – the US dollar

Due to the relatively low exposure of the US economy to cyclical sectors (like manufacturing) and the high use of US dollar denominated debt, the $US is a “risk-off” currency. It tends to go up when there are worries about global growth and down when the outlook brightens. So, moves in it bear close watching as a key bellwether of the investment cycle. 2022 saw a surge in the $US with safe haven demand in the face of worries about recession, war and aggressive Fed tightening. Since its high it has fallen which is a positive sign – but the decline has stalled at a high level suggesting a degree of caution. A further downtrend in the $US would be a positive sign for investment markets. So far though it looks stuck, which partly explains the softness in the $A which is a cyclical currency.

The $A and the $US v major currencies

Source: Bloomberg, AMP

Dr Shane Oliver – Head of Investment Strategy and Chief Economist, AMP

Important note: While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.

Introduction

Share markets have seen big falls on the back of rising recession fears. For the last two years there has been constant fears of a recession – or a contraction in economic activity – on the back of central bank rate hikes. With it failing to materialise and inflation falling enabling central banks to pivot to rate cuts many thought it would be avoided, and shares surged to record highs into July. However, recession fears are now back with a vengeance, particularly in the US, so share markets have fallen sharply from their highs – with the key direction setting US share market down 8.5% and global shares off 8.9% and Australian shares having a 5.7% fall from its high last week. What’s more, bond yields, commodity prices and the $A are all down consistent with renewed growth concerns. This may have been accentuated by an unwinding of so-called Yen carry trades (where investors borrow cheaply in Yen and invest globally) after the Bank of Japan raised interest rates. Even Bitcoin has had a near 30% fall from its July high indicating again it’s become a leveraged version of shares. So why the sudden recession worries? How serious is the risk? Does it mean central banks including the RBA have got it wrong? And what does it mean for investors?

More US recession indicators flashing red

The basic argument for recession over the last two years is that the most rapid monetary tightening in major countries in decades and cost-of-living pressures would depress spending driving a recession. Indeed, the Eurozone, UK and Japan have seen growth stall or arguably have had mild recessions over the last 18 months and Australia is already in a “per capita recession” (with falling GDP per person) even though GDP has still been rising. But the US economy has been robust, and this has kept the key direction setting US share market strong until recently. However, while the US economy has been stronger than expected, the risk of recession never fully went away, with key indicators highlighting ongoing recession risk. In particular:

• The US yield curve which is a guide to whether monetary policy is tight or loose has been flashing red, with short term interest rates above long-term rates, since 2022. And while this has given false signals it has preceded all US recessions over the last 60 years. It’s still inverted and so its recession signal remains.

US yield curve inversions and recessions

Shading shows recessions defined by the US National Bureau of Economic Research. Source: Bloomberg, AMP

• The US leading economic index – which combines things like building permits & confidence – has had a fall consistent with past recessions.

There is nothing new here. And with global growth running around average levels, business conditions indicators remaining solid and US growth still strong many concluded the recession indicators just got it wrong. However, the resilience in economic growth could have just been due to (what Milton Friedman long ago called) the “long and variable lags” with which monetary policy impacts economic activity. And the impact of rate hikes was stretched out this time by the reopening boost from the pandemic, household saving buffers built up in the pandemic and strong labour markets partly reflecting a shortage of workers.

These supports are now fading. Weakening US jobs data suggest that it may indeed have been long lags at work.  US job openings and people quitting for new jobs have been falling for some time now. Initially this may have been benign as slowing labour demand just pushed down job openings (and wages growth) but with unemployment remaining low.

US Job Openings and Quits

Source: Bloomberg, AMP

However, now falling labour demand is showing up in higher unemployment. Historically, small increases in US unemployment tend to be benign but once it goes beyond 0.5 percentage points it tends to keep rising and become associated with a recession as higher unemployment leads to lower spending in the economy. Based on this a US economist named Claudia Sahm observed that whenever the 3-month moving average of the unemployment rate rises by 0.5% above its prior 12 month low a recession has been underway. This has become known as the Sahm Rule and it was triggered by July jobs data in the US on Friday with unemployment spiking to 4.3%, up from a low of 3.4%. It can be seen at work in the next chart. It has a perfect track record, but relationships that work in the past don’t always work in the future and it may have been distorted by a lumpy 420,000 rise in the labour supply in July. That said it’s hard to ignore and suggests along with the still inverted US yield curve and the slump in the US leading indicator that recession risk is now very high in the US. Which is why share markets have plunged and the US money market is now back to allowing nearly 5 rate cuts this year. Recall it was expecting nearly 7 cuts early this year, so it’s almost gone full circle!

US Unemployment Rate and Recessions

Shading shows recessions as defined by the US NBER. Source: Bloomberg, AMP

What about Australia?

Leading indicators of Australian economic growth have not been as weak as those in the US. However, there are several reasons for concern that Australia may follow the US. We put the risk of recession here at 50%:

• Interest rates have gone up by more in Australia than in the US as measured by the mortgage rates people actually pay.
• Household debt servicing costs are now at a record share of household income in Australia (which is not the case in the US), and Australia has far more overvalued housing than in the US.
• Australian real household spending has slowed to a crawl.
• The boost to Australian economic growth from record population growth looks set to slow over the year ahead by at least one percentage point. This will more than offset the boost from tax cuts.
• Like in the US job vacancies have been falling here for two years and this will likely soon feed through to a sharp slowdown in jobs growth and rise in unemployment which is already up to 4.1% from 3.5%.

Australian employment vs Jobs Leading Indicator

Source: ABS, AMP

• US recession will drag down global growth which will mean less demand for our exports and indirectly impact via confidence.

Have central banks, including the RBA, got it wrong?

The global monetary policy easing cycle is now underway.  However, while lower interest rates are good for shares, this is less so initially in a recession and share markets are signalling increasing concern central banks may have left it too late. Central banks, including the RBA, may not have allowed enough for the “long and variable lags” with which rate hikes impact growth and inflation and so overtightened or left rates too high. This has likely been made worse by the pause in progress getting inflation down over the last six months in the US and then in Australia.  Because central banks never know when they have raised rates enough to control inflation they often go too far – resulting in recession. This was the case prior to recessions in Australia in the early 1980s and 1990s. While the RBA still faces inflation that’s too high, given the US experience it should now be giving consideration to a cut in interest rates as it now risks much higher unemployment and inflation falling below target.

What will recession mean for Australians?

A recession normally sees higher unemployment – the early 1980s and 1990s recessions saw a 5 percentage point rise, less job security, lower wages bargaining power, a fall in living standards and low confidence. Recessions eventually also mean lower growth in the cost of living and often lead to lower levels of immigration and less household formation which could take pressure off rents and home prices.

What would be the impact on shares?

Recessions in Australia and the US have tended to be associated with bear markets in shares, ie, 20% or more falls, as they drive a slump in profits. The next chart shows the Australian share market and falls in it against US recessions. Shares are vulnerable now as valuations are stretched, investor sentiment has been high, geopolitical risk is high with the US election and escalating problems in the Middle East and August and September are often rough months. So, it’s likely too early to buy the dip!

Equity Bear Markets and Recessions

Shading shows recessions as defined by the US NBER. Source: ASX, Bloomberg, AMP

Implications for investors

While times like these can be stressful, for superannuation members and most investors the best approach is to stick to an appropriate long term investment strategy to take advantage of the rising long-term trend in share markets given the difficulty in trying to time short-term swings.

Dr Shane Oliver – Head of Investment Strategy and Chief Economist, AMP

Important note: While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.