Markets & Economics

‘We live in interesting times’ and there is much to digest from a global economic and market perspective.

The share market rally that started late last year has been strong and despite a little recent weakness has been very resilient. The catalyst for the market rally initially was the prospect of lower interest rates (potentially significantly lower) as we entered the last month of 2023. The consensus view was that inflation would continue to fall and central banks would be able to cut rates numerous times during 2024. Long term interest rates (bond yields) fell significantly and the share market rose. Lower rates are positive for markets and economies as debt servicing costs for individuals, households and businesses are lower. This means more money can be spent in the economy fuelling better growth.

What has happened since? Inflation (in both the US and Australia) is proving to be ‘sticky’ and above the comfort levels or target range set by the central banks. Whilst inflation has fallen dramatically it is still high particularly compared to where it has sat over most of the past 15 years. In the US inflation is circa 3.5%. The Federal Reserve (the US central bank) has a target range for inflation of 1 – 2%. US economic growth is lower but still positive at an annualised 1.6% (based on the last quarterly number). Positive growth, low unemployment and above target inflation is not an environment that is conducive to lowering interest rates. And that is exactly where we find ourselves. In an environment where in the short term we do not envisage lower official interest rates. The economy would need to weaken further and / or inflation reduce quickly for imminent rate cuts to be back on the agenda.

The picture here in Australia is similar with growth, unemployment and inflation numbers basically the same. The stubbornness of inflation domestically has seen some analysts predict the official domestic cash rate may even need to be higher. Like the US, it is not an environment where rates will be cut in the short term. This is significant given the relatively high level of household / mortgage debt in Australia and the fact mortgage rates are priced off the RBA cash rate. Borrowers should not expect lower rates in the short term. Rate reductions may not occur now until 2025.

To date the equity market has largely taken the ‘higher for longer’ interest rate environment in its stride. Whilst volatility has increased a little the market has been resilient and held onto the gains made since November 2023. Valuations are higher than long term averages and it is challenging to find value in the market at present. But company earnings remain reasonable (earnings ultimately drive share prices over time). We advocate caution if you are investing cash into equity markets but are comfortable continuing to hold quality companies and managers.

Whilst the dominant factor for asset prices is the economic environment we also have a number of geopolitical issues that could weigh on markets. Any escalation in either the Ukraine / Russia war or the situation in the Middle East could see increased volatility and investors choosing safer haven investments than equities (such as cash or bonds).

The positive in all of this is that defensive assets (cash, term deposits and fixed income) are now providing a real return (above inflation) in portfolios. Term deposit rates at circa 5% allow money to be invested in a risk free environment and generate meaningful income.

As always we encourage you to contact our office to discuss your situation and the environment.

SCM Financial Group Investment Committee.