Monthly Market and Economic Update – September 2022

“If you have one economist on your team,
it’s likely that you have one more than you’ll need.” 

Warren Buffett

Key Points: 

• Inflation seems to have replaced global debt as the #1 worry.
• Inflation might peak soon but will it go away?
• Interest rates are still rising, how high will they rise?
• What did Jerome Powell (US Fed governor) say at Jackson Hole that spooked the markets recently?
• Recession looks likely, what does it mean for investors?

THE MARKETS

Is there another leg down?

The four key factors appear to be

• inflation,
• interest rates,
• earnings results and
• recession.

There are other factors however in short, a surprise to the negative on any one of these could see another leg down for markets and a new floor in terms of trading prices (like the Jerome Powell comments at the recent Jackson Hole meeting).

The blue line tracks the movement in the Dow Jones Index.  The yellow line shows the movement in the S&P 500 Index.  The turquoise line shows the movement in the NASDAQ Share Market Index.

Do you notice how difficult it is to work out what’s coming up in the future when you look at graphs like this and yet how crystal clear it is to see where we’ve been?!

There are lot of factors at play however it would appear currently that by some measures, the market could be considered fairly priced or even possibly oversold.

The percentage of stock prices above the 200-day moving average

The above graph shows the movement in trading prices by the number of stocks whose trading price is above the 200-day moving average.  To the right of the chart above you can see that recently around only 30% of total market trading prices remained above the 200-day moving average.

The graph above suggests that in terms of the 200-day moving average at least, markets could be considered fairly priced or even oversold.  Bear in mind this is a short-term indicator and one of those ‘play the share market’ indicators.

To be clear, this indicator does not necessarily value the share market, but rather compares trading prices with the 200-day moving average of trading prices.  Not exactly a fundamental metric but useful nonetheless in terms of establishing were trading prices are at compared to recent history.

Staying with this technical theme, recent data suggests that stock prices pushing back up through their 50-day moving average on July the 19th this year, is considered another indicator that the market is finding trading price support.  This doesn’t mean that trading prices are tracking in a one way upward direction.  It can change at any moment (e.g. the market’s response to The Jackson Hole meeting) but nonetheless it’s interesting to know.

Another technical indicator is the movement in the Russell 2000 Index.  This measures small caps.  Again some upward movement in the overall trading prices of small caps can suggest that markets are feeling some confidence.  That confidence though continues until it doesn’t.

Whilst July’s inflation number spooked the markets, more recent data is showing signs that, whilst inflation is far from rolling over totally, there are nonetheless some signals further into the future that inflation may be peaking.

That won’t mean that interest rates will suddenly drop.  It may mean that interest rate rises slowdown and eventually stop but that interest rates may remain elevated for longer.  The point here is that the market will be gauging the recessionary impacts of a high level of interest rates and looking to work out the impact on specific stocks.

Simply, tougher market conditions and a slowing economy may mean that some companies will announce either slower profit increases or indeed profit declines – either way the market hates these announcements with passion.

That’s why you’ll sometimes see some stock prices drop like a stone even though the company announces a minor miss on the top or bottom line number.

The above diagram shows the largest producers of natural gas around the world.

The price of natural gas in Europe has spiked hugely.  The increase in cost to European consumers is also nothing short of massive.  Costs are up by between five and ten times.  Imagine your power bill if it was $500 per month and it increased to $2,500 or $5,000 each month!

By contrast, other commodity prices in fact have rolled over and eased back from their peaks.  Oil is a good example which is hovering around $97 per barrel or thereabouts.

So, where does this leave things then?

Markets respond to certain economic news.

As I said at the top, the inflation number, providing it doesn’t surprise to the negative looks to be showing some signs of easing back.  It will be interesting to see how unemployment fits into the picture near term.  Unemployment as you know is near all-time lows which is accommodative to economic stability but is also inflationary.

Tighter employment creates wage demands which is inflationary.  In blunt terms, higher unemployment might be needed to assist interest rates in beating inflation.

Interest rate rises continue in the near-term.  The next interest rate hike is scheduled for later in September.  The question will be whether it’s 50 basis points or 75 basis points.  It is as they say ‘data dependent’ and so we need to wait and see.

Right now, my best guess would be 75 basis points so that the Fed increases its chances of getting ahead of inflation.

This brings us to earnings announcements.  So far they had been reasonably favourable.

Looking ahead though I expect more difficult economic and market conditions to impact on profit announcements over the next two quarters anyway.

To what degree will be interesting to observe.  I don’t see it being significant although market conditions impact many businesses differently.

This then leaves recession which at this stage would appear to be elongated and the questions yet to be answered revolve around the length and depth of any recession.

My best guess is that it’s not deep but could play out for many months into the future.

This in turn if correct would see markets track sideways for quite some time, possibly throughout 2022 and over much of 2023.

Jackson Hole

This is an annual meeting where the US Federal Reserve hosts other central bankers, policy makers, economists, and other academics from around the world.

Jerome Powel’s thinking that was already evident and well signalled seemed to surprise the market.  Share markets declined sharply in response on the Friday the comments were made (a brief 10 minute speech).

Such is the fickle nature of the market.  No matter, better buy prices for us.

Prior to the Jackson Hole Meeting where Jerome Powell gave a key speech around interest rates and markets, the surprise to me was that markets declined a couple of percent because of anxiety about what Jerome Powell might be about to say at the then upcoming Jackson Hole meeting (a bit like worrying about worrying).

It is worth remembering though that there are lots of different players across the markets.  A good many are traders and speculators who are very focused on every single piece of data that emerges by the minute.

That’s not our game of course.  We invest in the business and are happy to buy on pricing weakness with no need to be anxious about ‘negative’ data as it unfolds.  Data is just data.

The above graph shows market corrections (the blue bars) and bear markets (the red bars) since 1974 to-date.

Since 1974, based on the S&P 500 there’s been 26 ‘corrections’ (market pricing declines 15% or more).  Six of these have resulted in ‘bear markets’ (market trading price decline of 20% or more).

Interestingly, Morningstar data points out that if an investor had decided to exit their investments during a correction (and stayed out of the market for 12 months) they would have missed out on an average return of approximately 50% per annum (cut their return by half)!

The author of The Psychology of Money, Morgan Housel, made an interesting point…

“Every past market crash looks like an opportunity, but every future market crash looks like a risk.”

The Global Economy

The above graph shows where various countries sit with regards to the cost of living versus purchasing power compared to New York City.  New York City is considered to be sitting at an index of around 100% and so other countries are either similar, above or below New York City in terms of cost of living and purchasing power. 

We have all heard about inflation, it’s everywhere!

The problem with inflation is that it squeezes business profits and the spending power of everyday citizens. 

Simply, businesses make less profit in real terms.  The wage or salary of Mums and Dads and everyday citizens around the world just doesn’t buy as much at the grocery store and many other places.  This is the squeeze which becomes progressively tighter. 

Okay, some good news.  Whilst inflation is not going away anytime soon, we’re getting closer to peak inflation.  In other words, there are limitations to how tight things will be.  Things can only get so bad. 

The above diagram shows economic growth across the global economy, advanced economies along with emerging and developing economies over 2021, 2022 and 2023.

Economic growth and activity is sliding in a downward direction.

Although as the above graph shows, current projections from the International Monetary Fund show that, whilst economic recession is looking likely for the United States of America, Europe and possibly China, the global economy is projected to continue to grow over 12 month periods.

However, I suspect that the above numbers may be reset as new data continues to emerge over the following months.  In short, I expect growth across the global economy to slow further.

This doesn’t sound good although let’s keep in mind that slowing economic growth is not economic contraction and a long, long, very long way from economic depression.  I only mention the depression word for the purpose of comparison to demonstrate the fact that it is highly unlikely given the information available currently (let’s not get too carried away with doom and gloom).

Although there’s more to it, a strong economic contraction globally would be serious at which point we could expect central banks around the world to respond, as they’ve done in the past.

As I outlined under the section ‘Largest countries by economic activity’  in The Market and Economic Update last month, the US economy, despite growing debt has continued to grow and expand significantly over the last 30 years or so.

In the short-term, markets and economies ebb and flow.  This is normal.

You may recall that not too long ago, mounting levels of debt was all you could read about across the popular media.

Now inflation is everywhere.  Are you noticing a trend about the way information is reported across the mainstream media (anything to do with advertising and selling drama?)?

Let’s keep an eye on things that count but let’s keep our feet on the ground if you know what I mean?

The United States of America

The above graph shows the spike in food and energy prices and since 1960 how recessions coincide with the top of the spike.

Is America actually in recession already?

The short answer in my opinion is yes, sort of.

Economic contraction is real looking back over the last couple of quarters however, unemployment remains stubbornly low.  That’s why it’s weird.

The US Fed are raising interest rates to head off inflation.  Unemployment at low levels works against the US Fed and rising interest rates as consumers continue to spend.

In short, the US Fed will possibly be looking for unemployment levels to rise to help get on top of inflation.

That may lead to a more protracted recession.

The above graph shows the length of recessions from the past.  Use the horizontal axis across the bottom of the graph to measure the number of months and the vertical axis to the left to measure the size of economic decline.

Although no two recessions are the same, there appear to be similarities between what’s going on in the US economy at the moment and the 2007-2009 recession.  That was a big one by the way.

Although we need to be careful trying to extrapolate historical data into the future, we can see that market lows sometimes don’t occur for many months after interest rate rises.

For example, the US Fed stopped raising interest rates in June 2006 and market lows didn’t come until March 2009.  In another example, the Fed started cutting rates in January 2001 and the market bottomed in October 2002.  In September 2007 the US Fed started slashing interest rates and the market bottomed in March 2009.

These are just examples, and they don’t necessarily reflect where we’re heading.

Markets don’t care about your level of patience with regards to your portfolio tracking sideways.

The real point here is that whatever direction markets take in the short-term, wherever indicators emerge from across the economy, the quality of the businesses in which we invest determine how much money you make long term.  Let’s keep our eye on the quality of the business (too!).

Short-term price movement seems to capture our attention readily but is of limited value.

Imagine for example an investor who decided that when the market reached the bottom in March 2009 that they had had enough and that there were better investments elsewhere!?  Markets of course from that point went up and I remember advising my clients to invest (not bail out!) from around 2009/10 onwards.

Carefully at first and progressively as the markets continue to unfold.  A bit of old fashioned logic that when markets are low, without trying to apply too much science and keeping emotion out of it, there’s a good chance that those prices represent good value and it’s time to buy.

So, economic recession is real and likely to be protracted as things stand from here.

It could be that the US economy phases in and out of economic recession over a period of 1 or 2 years(?).  All the while of course for us, it is about taking advantage of favourable pricing along the way.

The Euro Area 

 Energy costs punish Europeans

The above graph shows the increase in the cost of specific items in Europe.

As the above graph shows, energy costs have spiked massively. 

It won’t last forever, however meantime there is pain for many everyday Europeans, particularly if it continues into winter. 

Annual inflation in the European Union jumped to 9.6% in the year to June 2022 as the Ukraine war cut off some energy and food supplies. 

This added to the supply chain problems that started during the pandemic. 

The Ukraine war also impacted on the European economy, so the Central Bank was reluctant then to raise interest rates.  This in turn saw the US dollar become relatively attractive compared to the Euro for the first time in 20 years.  This also added fuel to the inflation fire as imports in Europe have become even more expensive. 

Just to make matters more challenging, because of the heat wave and the drought, the Rhine River has become so low that some cargo boats were unable to carry coal and gas to where it was needed. 

In addition, Germany faces the ongoing prospect of Russia cutting off its gas supplies.

In general terms, the European economy has been relatively stable but there will be pain for businesses and consumers alike across Europe as, not only energy costs, but other costs are inflated, squeezing profits of businesses and the spending power of everyday citizens. 

China

The graph to the left tracks the Manufacturing Index as per the Purchasing Managers Index.  The line below 50 shows a decline.  The graph to the right shows demand for credit. 

Is China heading for recession?

Not if the Chinese Communist Party has any say about it! 

However, they’ll need to use all their tools in the toolbox to avoid economic recession over the next four quarters.

We can see that demand for credit has dropped off as the chart to the right above shows. 

We know that China trades significantly with Europe and of course they (Europe) are facing increasing struggles. 

As conditions deteriorated across the Chinese economy over the last few months, the Chinese Central Bank surprised the world (no one saw it coming) by easing interest rates back, admittedly by a minimal 10 basis points.  Not much but nonetheless possibly the start of something bigger?

Let’s step back with some perspective and think about what’s going on … we only have to go back over the last 12 months, think about the Chinese government’s zero tolerance policy for the Coronavirus, the resulting lockdowns in major cities and it becomes quite clear why the Chinese economy is starting to struggle now. 

The above graph tracks the movement in the price of iron ore and copper.

As per the above graph, we can see that demand for iron ore and copper has dropped off which suggests weakening Chinese demand.  Interestingly, China’s stock market appears somewhat detached now from the rest of emerging market indexes which has occurred since the onset of the pandemic and has grown further apart ever since.

From a geopolitical perspective, China appears to be taking on a much tougher stance with regards to its place in the world.

Evidence of that was the response to the Speaker of the US House of Representatives, Nancy Pelosi making a provocative trip to Taiwan.

China lashed out at America with stern warnings and followed through with live missile and artillery exercises designed no doubt to first, avoid any loss of face and secondly to show the world that China means business.

Further, an increasing number of Chinese companies are delisting from the US share market as political tensions and changing legislation in the US continue to impact.

You may recall that I advised my clients to exit Alibaba a while back because of concerns back then around new US legislation (Chinese company requirements to disclose communist party links).

Although it appears to be a moving target right now, currently economic growth forecasts which are sliding downward, are sitting at around 3.8% to 4.1% economic growth for the Chinese economy.  It wouldn’t surprise me if this number reduces further.

Although I’m no economist, I don’t necessarily see this data as a signal that the Chinese economy is crumbling.  Sure, the property sector in China is struggling somewhat.  However, I believe it is largely the impact of the Zero-Coronavirus policy, the lockdowns and the impact on economic activity over that period that is contributing to reduced economic activity and slowing economic growth.

So, there is further downside for the Chinese economy and of course that will have some flow on effect across the global economy too.  At the same time, the Chinese Communist Party as usual will be looking to control the Chinese economy with that iron grip.

Australia

The above graph shows past and estimated inflation up to around 2024.

Australia’s economy is projected to grow reasonably strongly over 2022.  However, the economy will feel the effects of slowing economic growth as its trading partners are impacted by inflation and rising interest rates. 

Near-term, economic growth in Australia is expected to be supported by household spending and a recovery in services exports.  However rising interest rates may start weighing on private spending.

The above graph tracks historical and projected inflation in Australia.

Like many other countries around the world, inflation in Australia is high, having been revised upwards a few months ago which reflects an increase in pricing pressures.

Inflation in Australia is expected to potentially ease over 2023 at some point.  As for 2022, inflation looks like peaking at around 7.5% towards the end of the year before potentially declining back to the top of the inflation target range by the end of 2024 (see in the inflation graph above).

The above graph tracks historical data and forecasts for disposable income, private consumption, and the savings ratio in Australia.

In the short-term, consumption is expected to grow but moderate in the medium term as higher prices and rising interest rates squeeze disposable income. 

Generally, the Australian economy continues to grow quite strongly compared to several other economies, although it too will feel the impact of a slowdown in global activity. 

Still, Australia remains well-positioned which is good because we trade closely with Australia and when they are feeling happy and comfortable, they’ll trade with New Zealand. 

For example, now that the doors have been opened to New Zealand we may see more Australian tourists spending money throughout the country – hopefully. 

New Zealand

The diagram to the left shows where Auckland sits on the global scene with regards to the cost of living and purchasing power.  Same for the chart on the right for Christchurch.

As the diagrams above show, as you would expect, Christchurch is a less expensive place to live when compared to Auckland.  No surprises there.

We all want Adrian Orr, the Governor of the New Zealand Reserve Bank to be successful as he attempts to get ahead of inflation here in New Zealand.  Less pain for the people that way.

Arguably he started earlier than many Central Banks around the world and is making good progress with regards to rising interest rates (to combat inflation).

Good progress is underway however it will be a question of how much help he’ll need with rising unemployment to get the job done.

Inevitably that’s going to lead to pain for certain pockets of New Zealand’s population.  Better that though than the much bigger pain if inflation is not brought under control – ASAP.

Economic Growth (GDP) – New Zealand

The above graph tracks economic activity and growth in New Zealand as measured by Gross Domestic Product (GDP).

New Zealand’s economy is doing okay although to cut to the chase, we need to be more productive. 

The reality is that the strong spending conducted by the Labour Government, some of which has been appropriate due to the Coronavirus, but some of it becoming questionable without increasing productivity, can send New Zealand down the so-called ‘slippery slope’ to third world status.  Spending money without making enough of it is not a good idea, simple as that. 

New Zealand’s economy grew by 1.2% over the 12 months ended March 2022, slowing from 3.1% in the previous period.

On a quarterly basis, economic growth in New Zealand shrank by 0.2% in the first 3 months of 2022 after rising 3% in the previous quarter.  The March 2022 quarter included a low level of travel due to border restrictions over that time.

The above table shows the movement in the population base for the year ended June 2022.

It would appear that between rising interest rates and, not only low immigration, but now increasing migration out of New Zealand, the government may eventually get their wish of being able to say that they’ve dealt with the ‘housing crisis.’

New Zealand needs improved productivity – not ongoing border restriction.

Without people to do the jobs that are needed now, not to mention the future jobs that would be created with growth, we may find ourselves in another crisis with a lack of economic activity/growth and more importantly, productivity to help New Zealand pay for the money being spent.  We need more people in New Zealand.

The above graph tracks the aging population in New Zealand.

As we can see from the graph above, in addition to arguably the wrong immigration policy underway now, we have a decreasing working population here in New Zealand declining at pace.

The graph to the left highlights the impact of a shortage of workers on production.  The graph to the right measures the difficulty in finding staff here in New Zealand. 

There are a variety of reasons why countries and their economies are not as productive as they could be.

Right now though it would appear that the shortage of labour is a key contributor, not only here in New Zealand but around the world. 

Is the New Zealand government doing enough to help rectify the situation?

The above graph tracks the unemployment rate in New Zealand historically and forecast to 2024.

As you know, unemployment has been sitting around record lows.  At a time when New Zealand is tracking close to recessionary conditions, unemployment is unusually low – not helping The NZRB combat inflation.

The point here as mentioned earlier is that we may need to see increasing unemployment alongside rising interest rates to help get ahead of inflation.

Bank Term Deposit Rates

The table to the left shows mortgage interest rates in New Zealand.  The table to the right shows term deposit rates.

Although interest rates are rising reasonably strongly, they remain relatively low and accommodative looking at historical norms.  It could be that mortgage interest rates have the next one or two monetary policy statement interest rate hikes built in already to some degree.

Those interest rate rises are likely to be somewhere in the vicinity of 50 basis points.   75 basis points is possible although in theory, the Reserve Bank is getting to the later stages of those interest rate hikes (based on current data).

Interestingly though, the US Federal Reserve at its Jackson Hole meeting recently stated strongly that they’ll continue to raise interest rates for as long as they need and as high as they need to go.  That could put further upward pressure on interest rates here in New Zealand to some degree.

We are tracking somewhat close to recessionary conditions although, as I’ve mentioned previously in other communications, recession is not a good thing for many (apart from lower trading prices) but it’s not the end of the world either.

It does tend to squeeze certain sectors of the population and make life difficult with some pain. Not ideal.  However, as the credit cycle continues to shift – totally normal.

To Summarise …

Looking big picture on the global scene, we can see that inflation could potentially peak over 2022 as supply chain bottlenecks begin to dissipate.

Slowing demand due to rising interest rates and weaker sentiment may help curtail future inflation and at least stop it from rising.  Inflation will linger at elevated levels for a while.

One factor that we’ve forgotten about of late with all this talk of inflation, is the deflationary impacts associated with innovative technology that disrupts incumbents materially over time.  That disruption can be deflationary.

That is still at play but takes time to work its way into the economic system.

However we want to measure it, recession in America and other countries around the world is not if, but when.

Arguably America has been in recession already as the newly revised numbers around GDP continue to emerge.  Indeed, they continue to revise the numbers on GDP in America for many months and so it’s difficult to know what the actual number really was for quite some time.  By then, we’re into another quarter.

Central banks around the world have walked the tightrope of balancing rising interest rates against recession.  Unemployment may need to rise to help rising interest rates combat inflation.  The reality is, the sooner the better.

The longer inflation is allowed to take hold the more punishing it will be on everyday citizens and small business owners around the world.

Markets run from moment to moment in a form of disorganized chaos, lurching at times from one extreme to the next at any point.  That said, we did see quite a stable run up in trading prices from 2010 to 2020.  One of the longest bull markets in history.

Economies to some degree are less disorderly with various mechanisms used by central bankers and governments in an attempt to control certain aspects of their economy.

If you run a communist regime or a dictatorship, then you’re likely to be less concerned about how people feel about the way you run the country to some degree.  On the other hand, in a democracy the idea is to get voted back in again.  The things that political parties and politicians do to get voted back in!

For example, by spending money, this appeases the voting population and increases one’s chances of getting the vote once again when the next election comes around (2023 here in New Zealand).

Meantime though, whilst we’ve all got our opinions about how we might do things better or differently, you and I can continue to position ourselves in the markets with pricing that is better now than it’s been for some time.  That’s a good thing.

‘Better to light the candle than to curse the darkness.’ – Old Chinese Proverb