Equity markets amid disinflation and economic growth
In this week’s video insight, I explore the equity market’s outlook, stressing the balance between disinflation and positive growth against the backdrop of potential inflation and economic slowdowns. Market dips, while concerning, are seen as opportunities, especially in smaller companies, provided inflation or recession risks don’t materialize. I highlight the significant role of the U.S. Federal Reserve and central banks in shaping expectations through interest rate policies. Recent shifts in market sentiment, driven by economic data and Fed caution, illustrate the challenge of forecasting amidst these uncertainties.
Transcript:
I believe the prospects for a good year in equities hinge on a backdrop that combines disinflation (declining rate of inflation) with positive economic growth. There will be fears that inflation spikes and economic growth stalls or slides backward, and those fears alone will be enough to cause the equity market to stumble. However, as long as those fears aren’t realised, any slide in equities represents an opportunity to add to equity holdings, especially small caps.
Importantly, if inflation reasserts itself or a recession does transpire, the good times for equity investors may end.
With that in mind, it is worth spending a little time thinking about what central banks, particularly the U.S. Federal Reserve, think about these issues. Their utterances about the path of interest rates must surely provide an insight into their expectations for both growth and inflation, and it is fair to say that as April unfolds, the economic narrative that once seemed certain is somewhat flecked with complexities.
Not long ago, economists and commentators were betting on a series of Federal Reserve interest rate cuts commencing in June, envisioning an economy that would smoothly transition to a ‘soft landing’. However, recent developments have clouded this straightforward scenario.
Merely a month ago, the CME Fedwatch tool, a barometer based on futures prices, signalled a robust 74 per cent likelihood of at least one rate cut by June. Fast forward to today, and this prediction has softened dramatically to a less certain 58 per cent — effectively a coin toss.
This shift is not without reason. A fusion of strong growth data and the Federal Reserve officials’ hawkish sentiments has jolted markets into a reassessment, pushing the prospect of rate reductions to be both milder and more distant. These reassessments inevitably cause market setbacks and are somewhat predictable.
Indeed, back in November, in a blog post entitled The RBA Acknowledges Boomers Win and Mortgagees Lose, I wrote, “Contrary to expectations of declining interest rates, we might find ourselves looking back in a year’s time and discovering that rates have remained stubbornly stable and high.”
This time around, markets appear particularly reactive to evolving expectations. The first few days of April have already seen a sell-off in longer-term bonds, propelling the yield on the 10-year Treasury note from 4.21% to 4.41%. This movement was partly ignited by a robust report on manufacturing activity from the Institute for Supply Management.
Meanwhile, several Federal Reserve officials have promulgated a cautious stance against premature rate cuts. For instance, Atlanta Fed President Raphael Bostic now sees the possibility of only one cut towards the year’s end. Cleveland Fed President Loretta Mester and Fed Governor Christopher Waller have echoed similar sentiments, emphasising the economy’s resilience and the potential inflationary risks associated with hasty monetary easing.
At the heart of these discussions, Federal Reserve Chairman Jerome Powell’s recent statements provide a nuanced view. Powell, speaking at the Stanford Graduate School of Business as I write this blog, has emphasised a need for patience, reinforcing previous announcements the Federal Reserve would not consider lowering rates until there’s a clear path towards achieving a sustainable two per cent inflation rate.
While the approach of making policy decisions “meeting by meeting” reflects a deliberate and data-driven strategy, it highlights the cloudy nature of the current state of affairs.
The bottom line is that robust U.S. growth figures and ongoing inflation concerns are installing a few roadblocks in front of an otherwise optimistic outlook. But, for now, as I mentioned here, we can earmark rather fear descriptions of the market being ‘exuberant’ or in a bubble.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
