It has been a dizzying few weeks as strong economic and (persistently)high inflation data have continued to drive incredible volatility...
It has been a dizzying few weeks as strong economic and (persistently)high inflation data have continued to drive incredible volatility, and we are back within a few percentage points of year-to-date lows in both the US and Australian markets. Our argument of late has been that the volatility is appropriate as data continues to swing wildly. Still, we have now seen the playbook for what a recovery in the market will look like, with the bounces in July/August and brief rally at the beginning of this month providing a blueprint. In both cases, the catalyst was the changing view that inflation and interest rate expectations had peaked, and both rallies reversed once it became apparent that inflation was continuing to surprise to the upside.
There’s no doubt that inflation continues to astound, and it may prove harder to tame than anyone thought possible. Additionally, we may see central banks over-correct and push economies into deeper-than-needed recessions, which would impact revenues, margins and earnings for many listed companies. In this case, stock selection will be critical. However, in general, counterintuitively, equities could perform strongly in a recession as price/earnings multiples increase as central bankers are forced to ease monetary conditions to stimulate the economy once again. Tightening monetary conditions have been the catalyst for a falling stock market and easing monetary conditions will logically be the reason markets start recovering.
The rally on Friday was particularly unusual in that it came after another stronger-than-expected inflation reading and followed an early sell-off in the US trading session. Subsequently, we experienced a sell-off on Friday night, followed by another big rally overnight. This is further evidence that the market stands ready to rally once data starts to turn around. In this case, it seems informative that bond yields didn’t fly when inflation data disappointed again and suggests that the market has moved on from a glass half empty to the early signs of a turn in sentiment. And, as we’ve discussed in previous market updates, history has shown us that returns following significant market corrections have always been the strongest. For that reason, we continue to believe that it is more dangerous to sell one’s portfolio today than to continue holding (admittedly through gritted teeth).
