Let’s commence this month’s review on a positive note with Australian share market now decisively in the green territory. Considering much macro uncertainty, the investment returns are nothing short of impressive at 10.4% for twelve months to 31 March 2022; six months return at 2.3%; and one month return of 6.4%.  In fact, the share market is a mere 2% short of reclaiming the historic high it reached in August last year.   

You may be scratching your head and wondering what about the risk of inflation that everyone seems to be focusing on right now and how it is expected to lead to interest rate increases and affect the economy? 

We don’t believe the share market is making light of the risk of inflation to the economy.  In fact, it is acutely aware of the risk of inflation potentially being mismanaged by companies resulting in margin squeeze and lower sales volume, particularly in discretionary expenditure as consumers cut their spending to balance their ever-tightening household budgets.    

But, the market is also aware that many of the Australian industries and companies hold strong market positions to pass on the higher cost of doing business by raising prices for the goods and services they sell.  Take the banking sector for examples, every time there is even a hint of rising interest rates the banks are sure to pass on the rate increases in equal measure (sometimes more) to the borrowers. In fact, during periods of rising interest rates banks’ profitability also increases, and it is for this reason banks’ share prices have shown a decent turn around in recent weeks.

Other examples of companies with strong market positions include Telstra, Coles & Woolworths, Wesfarmers, and Insurers such as Suncorp.  Costumers of above companies are price takers.  For instance, Telstra recently raised the price of its monthly mobile data packages and announced to their existing customers to expect the price increases at the next bill.  Whilst not a great outcome for customers of Telstra as they are dependent on its strong network coverage but great for its shareholders as it seeks to maintain its profitability.  Telstra’s market power increased even more recently after the merger of TPG and Vodafone. 

The other reason why the market is, thus far, taking inflation in its stride is that it knows the consumers are sitting on considerably strong financial position built up in recent years – please see the chart above right.  Which means consumers have the financial fire power to afford higher prices for goods and services. Moreover, the unemployment rate is expected to remain at record low over the next couple of years which should continue to support economic growth.

Thirdly, the Australian politicians are now in campaign mode for the next federal election possibly in May 2022, which means policies are being rolled out to alleviate the financial pressure on voters.  A number of announcements in the recently delivered federal budget are stimulatory e.g. the fuel excise tax is cut by 22 cents per litre for six months plus $250 cash handout to millions of Australians within weeks.  All this extra money will inevitably transmit to businesses through purchases of goods & services.      

The other major uncertainty for the market at present is the war between Ukraine & Russia.  The threat of significant disruptions to the supply of oil & gas from Russia to Europe and the world remains elevated.  The base estimate of the market is that energy will continue to flow despite the war, however, if the flow of energy does stop then inflation will rise significantly, globally.  That would slow down economies everywhere and cause markets to come off.  However, there are stark parallels between Russia/Ukraine War and Israel/Egypt war in October 1973 which also caused significant disruption to oil supplies for six months (October 1973 to March 1974) and caused 300% increase in oil price.  At that time, whilst equity markets did have a sell off during 1973 and 1974, the markets did bounce back strongly in double digits over 1975 and 1976.  

So, the message for investors is to remain invested in good quality companies with strong market positions across range of sectors, primarily selling essential or value adding goods & services.            

ECONOMIC NEWS

Reserve Bank of Australia’s (RBA) decided to keep the benchmark interest rate unchanged, however, warned Russia’s invasion of Ukraine has the potential to prolong a period of elevated consumer-price growth and is clouding the economic outlook.

Purchasing Manager’s Index (PMI) increased in March with both input cost and output price inflation hitting records and consumer sentiment tumbled to lowest since September 2020, amid Russia’s invasion of Ukraine, flooding in the nation’s northeast, rising prices and the prospect of higher interest rates.

Over in the U.S., President Joe Biden unveiled a $5.8 trillion budget for 2023, marking a +5.7% increase from the omnibus spending bill for 2022 that was signed by Biden earlier in March. The budget includes significant increases in funding for the military and police departments, along with higher taxes on corporations and the wealthiest Americans. The most notable spending increase was US$773 billion military proposal, a 10% rise amid threats including Russia’s invasion of Ukraine and concerns about China’s ambitions.  Incidentally, the budget put far less emphasis on the types of grand social, climate and economic policies that Biden announced last year which have since run into resistance from moderate Democrats.  The budgets is also addressing rapid inflation which has dented Biden’s ratings.  He is expanding port infrastructure and inexpensive housing stock as measures to bring down prices over time by improving supply.      

U.S. business activity advanced to an eight-month high in March and hiring remained robust in the month with nonfarm payrolls increasing by 431,000 which combined with an increase in labour force participation rate and saw unemployment rate decline to 3.6%, near pre-pandemic low.

In Europe, inflation surged in March with CPI increasing +7.5% p.a. to an all-time high, however, European Central Bank (ECB) signalled it would accelerate winding down its asset purchase program despite the economic uncertainty from the war in Ukraine.  This would involve slowing down its bond buying to 30 billion euros in May followed by 20 billion euros in June. ECB has downgraded Europe’s economic growth (GDP) forecast for 2022 to 3.7%, and 2.8% in 2023 while 2024 was unchanged at 1.6%.  The unemployment rate forecasts for 2022 at 7.3% is unchanged and should remain at these levels for the next two years. ECB upgraded the inflation outlook for 2022 to 5.1% but expects it to come down to 2.1% in 2023 and even lower in 2024 at 1.9%. In actual numbers though Euro-area inflation surged in March with CPI increasing +7.5% p.a. to an all-time high.

United Kingdom’s Central Bank (BOE) raised interest rate for the third successive policy meeting, increasing by 0.25% to take borrowing costs back to their pre-pandemic level of 0.75%, and warned the war in Ukraine may push inflation well above 8% in June quarter 2022 vs prior forecast of 7.25%. U.K. Chancellor Rishi Sunak announced a 6-billion-pound tax cut for workers, slashed fuel duty and signalled a future reduction in income tax, after UK Treasury downgraded its 2022 economic growth forecast for U.K. to 3.8% and for 2023 to 1.8%, however, upgraded 2024 to 2.1%.  U.K.’s inflation is forecast to hit a 40 year high of 8.7% at the end of 2022 (vs BOE’s outlook of 8%) and average 7.4% for 2022, almost double prior forecast of 4%, outpacing wage growth and causing a -2.2% decline in real living standards in the 2022-23 fiscal year, largest financial year fall on record. Living standards are not expected to recover to their pre-pandemic level until 2024-25. 

Over in Japan, the Bank of Japan (BOJ) left its interest rates and asset purchases unchanged and downgraded its assessment of the economy, however, doubled down on its commitment to continue with stimulus, offering for the first time to buy an unlimited amount of 10-year government bonds for three straight days.  This was despite predicting annual inflation could accelerate to around 2% from April onwards.   

In political news:

• Geopolitical tensions continued to escalate with no compromise being reached between Ukraine and Russia, leading to more countries imposing sanctions on Russia, making it the world’s most-sanctioned nation and U.S. President Joe Biden calling for an end to normal trade relations with Russia and barring imports of the nation’s vodka, caviar and diamonds.
• U.S. and U.K. struck trade deal to end tariffs on British steel and, American whiskey and motorcycles.