Market Update: May 2022

Market Update: May 2022

Market Overview

May was a poor month for markets across the globe. The Australian market lost 2.6% and globally tech stocks again felt the brunt of increased interest rate expectations as inflation continues to embed itself into the major economies. We summarise the performance of key markets below.

The big news continues to be around inflation and the increases in interest rates. The RBA investors by raising its cash rate target by 50bps to 0.85% last Tuesday. The increase exceeds expectations of 25bps and triggered a sharp selloff in Aussie government bonds and banking stocks. Governor Philip Lowe delivered a hawkish statement, indicating that the central bank is committed to reining in inflationary pressures and will therefore continue to tighten monetary policy. Falling house prices and weak consumer confidence indicate that the RBA tightening is already gaining traction.

AMP Chief Economist Shane Oliver expects the RBA to raise the cash rate to 1.5% – 2.0% by year end and to peak at 2-2.5% by mid next year. This contrasts interest rate markets which are currently priced for the Cash Rate to reach 2.4% and 3.1% by the end of 2022 and 2023 respectively. Oliver’s views are that the economy has greater sensitivity to higher interest rates and this will cap how much the RBA will ultimately need to hike in order to subdue inflation.

The large uptick in rate expectations has been bad news for fixed rate bonds, which include government bonds. This is because the previous fixed income (coupon) rates become less attractive as new bonds are issued with higher rates. The balance of existing bonds on the market is reduce in price so the yield can match these new bonds. This has resulted in material losses for (risk free) government bonds being of over 10% during 2022.

The below chart highlights the drastic changes in returns in the past 6 months versus those experienced during 2021, where previous very strong return in US equities being reversed and the losses with government bonds.

An election was held during May which surprise surprise, has had zero impact on investment markets. The lack of policy on both sides has seen no reaction either way in share markets as a result of the Labor victory.

Turning back to markets, with the decline in stocks, particularly the US which has dropped over 20% (and the Nasdaq tech index over 30%) this calendar year, we are seeing the real impact this is having on valuations, with the US price earnings ratio coming way down and is at much more favourable levels.

However, the problem we are faced with is that market expectations for the ‘E’ (earnings) part of the ratio remain relatively high, with the expectation that companies will grow their earnings 10% for 2022 and then a further 10% in 2023. This seems optimistic, particularly with the huge input costs facing most business, such as fuel costs. The below chart of the marine diesel price puts some perspective on the scale of this.

The Australian market didn’t see such high valuations as the US, and during 2022 we haven’t been hit as hard given very strong earnings in the resources and energy sectors. Industrial stocks though remain highly valued and vulnerable to further valuation based drops.

End of Financial Year

There is still time for those to look at various tax planning measures before the end of financial year. Of particular importance is the use of super contributions to gain an upfront tax deduction and also a means to top up on recent weakness. The current year’s ‘concessional contributions cap’ is $27,500 and there is also the ability to make contributions beyond this cap should you be eligible. Further details available here https://www.ato.gov.au/individuals/super/in-detail/growing-your-super/super-contributions—too-much-can-mean-extra-tax/?page=5

Please contact your adviser asap should you have any questions around this.