Correction time for shares? The huge gains in share markets since their October lows left them technically overbought with stretched valuations and high levels of investor optimism which left them vulnerable to a bout of volatility or a correction which now appears to be unfolding with concerns around US inflation and interest rates and fears of an escalation in the war in the Middle East threatening global oil supplies providing the trigger. From their recent highs global and Australian shares have fallen by around 4 to 5% and the short-term risks remain tilted towards further falls. The last correction played out over three months into last October and saw shares fall by 9 to 10%. However, we are inclined to see the current moves as a correction rather than something deeper and continue to see further gains in shares this year once the correction is over as inflation slows, central banks still cut interest rates and recession is avoided or proves mild.
Israel/Iran escalation averted? Iran’s 13 April retaliatory missile attack on Israel was well flagged and caused minimal damage and looked designed not to escalate things too badly. And Israel’s 19 April counter-retaliatory attack was modest causing little damage suggesting that Israel has chosen not to escalate, likely under US and European influence. Iran has also downplayed the attack and signalled no further retaliation. So, the crisis may be averted for now. Of course, the risks remain high with Iranian proxy attacks likely continuing and Israel at high risk of taking action against Iranian nuclear capabilities at some point. But at least the threat of a major disruption to global oil supplies looks to have been averted for now.
Fed rate cut delays remain a key focus for markets. Fed Chair Powell basically confirmed the less dovish outlook for interest rates that markets had already priced in with Powell indicating that inflation data has not provided the Fed with the greater confidence it wants and so it’s appropriate to leave rates high for longer. Interestingly, there was nothing from Powell suggesting higher rates – he doesn’t see the economy overheating but still sees the labour market moving into better balance and wages moderating helped by a boost in supply from immigration and rising workforce participation. Our base case remains for the first cut to come in September, although a July move is still possible.
However, the news regarding other countries in relation to inflation and central banks has been more mixed, highlighting the potential for a divergence with the Fed. The UK, NZ, Japan and Canada all saw further falls in underlying inflation in March. In the UK and NZ there are still concerns about high services inflation so rate cuts there look unlikely until around August or October and Japan has barely started with rate hikes. But in Canada a rate cut is looking probable in June with BoC Governor Macklem commenting that “we don’t have to do what the Fed does…we do what Canada needs.”
Similarly for the RBA – it doesn’t have to do what the Fed does! The combination of continuing economic growth, the still tight labour market and sticky services inflation mean that the RBA, like the Fed, is in no hurry to cut and that there is a very high risk that our expectation for rate cuts from around mid-year is too optimistic and that cuts won’t come till later this year. However, the RBA has not always just followed the Fed – after the GFC it started hiking in 2009 when the Fed was on hold near zero and the RBA was cutting and holding rates when the Fed was hiking over the 2015 to 2018 period. And right now, the Australian economy is far weaker than the US – with GDP growth less than half the US pace and consumer spending far weaker. As can be seen in the next chart the rise in interest rates over the last two years has had a far more negative impact on Australian than US households with debt servicing taking up nearly 20% of household income here compared to around 7.5% in the US. The reason is that household debt to income ratios are much higher here and average mortgage rates actually paid on outstanding housing debt have gone up by more than 3 percentage points in Australia compared to only about 0.5 percentage points in the US thanks to 95% of US mortgages being multi-decade fixed rates. So, the RBA starting to cut before the Fed may turn out to be justified, particularly if inflation data in the next week continues to show a further decline at a faster pace than the RBA is forecasting.
Trump is near! – US/China trade war ramping up again. After a few years of relative quiet but with President Biden largely maintaining the Trump era tariffs on China, he has now called for a tripling in tariffs on certain Chinese steel and aluminium imports to the US (from 7.5% to 25%). The direct impact on China and hence any flow on to Australia and more generally the US and global economies will be minimal as China only accounts for 1% of US steel supply and 3.6% of US aluminium imports. However, the populist protectionist move is clearly aimed at shoring up Biden’s support in key industrial states like Pennsylvania that he needs to win in the coming election. Further tariff hikes are likely in the run up to the election, eg on Chinese EVs and the US moves runs the risk that other countries will follow with tariffs on Chinese products. This is nothing compared to Trump’s talk of a 60% tariff on Chinese imports. But its yet again more evidence that globalisation is in retreat with protectionism on the rise (evident in Australia too with “Further Made in Australia”) which will result in a slightly more inflation prone world, higher than otherwise interest rates and lower than otherwise price to earnings ratio on shares over time.
The IMF revised up slightly its global growth outlook. Reflecting the unexpected resilience of the global economy, the IMF again revised up its global growth forecasts for 2024 to 3.2%, which is the same as 2023 turned out to be. The upgrade was mainly due to stronger US growth though (at 2.7%) with other advanced countries including Europe, Japan, Canada and Australia far softer. The IMF’s 2025 forecast was unchanged at 3.2%. That pace of growth is pretty much what was seen in the pre-Covid period.
Economic Activity Trackers
Our Economic Activity Trackers are still not showing anything decisive, but they have fallen over the last week.
Major Global Economic Events And Implications
Mixed US data with a strong consumer but soft housing. Retail sales rose more than expected in March with February revised up suggesting the consumer is solid, although the strength over the last two months looks partly due to weather and seasonal distortions. Industrial production growth was also solid, with manufacturing conditions in the New York and Philadelphia regions improving in April but still soft on average.
US housing starts fell sharply in March, existing home sales fell, home builder conditions were flat in April and the flow on off the rise in bond yields and hence mortgage rates point to a slowing in housing indicators ahead. Meanwhile, the Conference Board’s leading index resumed falling again in March but initial jobless claims remain very low. Meanwhile, the Fed’s Beige Book of anecdotal evidence was “cautiously optimistic” on the outlook referring to “slight to moderate growth”, “moderate” wages growth and “modest” price increases.
So far so good for US March quarter earnings. Only 14% of S&P 500 companies have reported so far but 80% have beaten expectations, against a norm of 76% and earnings growth expectations have increased to 4.7%yoy, from 4.1% a week ago.
Canadian underlying inflation fell more than expected in March. Headline inflation ticked up to 2.9% with higher fuel prices but the underlying measures fell more than expected to an average 2.95%yoy, leaving the BoC looking like it might cut rates in June.
UK inflation fell in March but by less than expected. Headline inflation fell to 3.2%yoy and core inflation fell to 4.2%yoy, but sticky services inflation at 6%yoy will keep the BoE cautious with rate cuts unlikely until August. Similarly, although jobs fell in February and unemployment rose, wages growth slowed less than expected.
But NZ inflation fell more than expected in the March quarter. Headline infaltion fell to 4%yoy with underlying measures of inflation also down and the quarterly pace of headline and underlying inflation now running below the top of the 1-3% target range. Non-tradeable and services inflation remain a problem with rate cuts expected this year but not until around October.
Japanese inflation also fell in March. Headline CPI inflation fell to 2.7%yoy from 2.8%, and core inflation fell to 2.2%yoy from 2.5%.
Chinese March quarter growth better than expected. Chinese property data remains depressed with further falls in property prices, sales and investment. But so far the rest of the economy is still growing at a mostly okay pace. March quarter GDP rose a stronger than expected 5.3%yoy, March retail sales and industrial production rose less than expected but investment rose more than expected. And a pick up in PMIs is a positive sign. Overall the Chinese economy looks on track for growth this year of around 4.5-5%. That said more policy stimulus is likely to be required.
Australian Economic Events And Implications
The Australian jobs market remains tight, but it is gradually cooling. While employment has been volatile lately due to changed seasonal patterns, trend jobs growth is still strong, hours worked is up, unemployment and underemployment remain low and the proportion of the population employed and the participation rate are still around record highs. All of which tell us that the jobs market remains tight – far tighter than we anticipated would be the case. However, there are signs of a gradual cooling with both unemployment and labour underutilisation up from their lows.
Furthermore, our Jobs Leading Indicator continues to point to slower jobs growth on the back of falling vacancies & hiring plans.
The tight but cooling jobs market can be seen in the gap between the demand for and supply of workers. This can be proxied as the gap between the sum of employment and job vacancies (ie demand for workers) and the labour force (ie labour supply). As can be seen in the next chart the gap remains high but has eased from near zero. The cooling but still tight jobs market will leave the RBA cautious on inflation and in no hurry to cut rates, for now. That said, the Australian jobs market may be seeing a similar positive supply shock to that in the US with strong immigration and high workforce participation absorbing job vacancies and heading off stronger wages growth even though jobs growth is still strong. If this continues to be the case, rate cuts will still ultimately be justified even if jobs growth remains strong.
Meanwhile, monthly arrivals data up to February suggests that while immigration may have peaked it remains around record levels. This means jobs growth needs to average around 39,000 a month at present to absorb the new entrants to the workforce on the back of very high immigration levels. And we should be building around 250,000 dwellings a year to keep up with population driven housing demand but with completions running around 170,000 we are just adding to the housing shortfall.
