Have the market falls come to an end?

I have been asked this question a lot lately and wanted to provide some insight into what is occurring in the economy and then how this may impact the stock market.

I have been asked this question a lot lately and wanted to provide some insight into what is occurring in the economy and then how this may impact the stock market.

The United States Gross Domestic Product or GDP (which is the total dollar value of all goods and services produced in a country) has fallen into negative territory over the last 6 months. The American economy shrank by -0.9% between April and June 2022, following a -1.6% drop in the first quarter and technically entering a recession. Inventories and business investment were the main drags. Inventories declined mostly at general merchandise stores as well as motor vehicle dealers. Residential investment sank 14%, spending on goods fell 4.4% and government consumption went down 1.9% while exports jumped by 18%, led by industrial supplies, materials and travel. The inflation rate in the US is currently 9.1% (annualised) and the unemployment rate is at 3.6%.

When you have two quarters of a negative GPD, it is the technical definition of a recession.  A falling GDP means consumer demand has fallen and companies then respond by producing less. The difference from other recessions is that unemployment is still very low. Whether this recession continues or becomes deeper will depend on a number of factors including whether companies start to lay off workers due to falling profits.

Australian GDP growth has also slowed from +3.6% for the quarter ending December 2021 to +0.8% for the January to March 2022 period – the growth rate has fallen but is not yet in negative territory. The inflation rate is currently 6.1% (annualised) and our unemployment rate is 3.5%. Australia’s economy is dominated by the services sector (65% of GDP); yet its economic success in recent years has been based on mining (13.5% of GDP) and agriculture (2%) as the country is a major exporter of commodities. Other sectors include manufacturing (11%) and construction (9.5%).

Australia’s largest export markets are China (32% of total exports), Japan (16%), South Korea (7%), USA (5%), India (4%), New Zealand (3%) and Singapore and Taiwan (3% percent each). Therefore a fall in demand from these countries, and in particular China and Japan, will have a significant impact on our economy.

China’s GDP growth rate has also fallen from +1.4% at the end of March 2022 to -2.6% for the June quarter. However, their annual inflation rate is just 2.5% and their unemployment rate is 5.5%.

One positive outcome from this falling GDP is that the Reserve Bank of Australia may look at slowing the pace of interest rate rises if inflation starts to moderate. Inflation usually starts to fall when you have falling demand and falling GDP as businesses compete for diminishing supply of customers. However, if wages increase at the same time without productivity improvements, then inflation could continue to increase which means we could end up with Stagflation, which is falling GDP while inflation increases.

The Reserve Banks of countries around the world will be looking closely at their economic data to determine if further interest rate rises are required in their respective countries or reducing the magnitude of future rate rises. The good news is that the interest rate rises to date are having the desired effect of slowing down the economies of a number of countries but whether it is able to slow the rate of inflation remains to be seen.

There are other factors at play such as the War in Ukraine, supply bottlenecks and rising energy/oil prices among others which impact inflation and business trade and profitability.  This article focuses on the end result of these forces, including the recent interest rate rises, which shows up in the GDP, inflation and employment figures.

So how does this impact financial markets going forward?

Stock markets are a forward looking mechanism and a lot of the negative sentiment, past data and future expectations have been factored into current share prices. Professional investors will be looking at whether company earnings data in the next round of announcements are better or worse than expected. If earnings and profits of a company are better than expected, then its share price is likely to improve. If the opposite occurs, i.e. earnings and profits are worse than expected, the share price will likely fall. If more companies on a whole beat expectations, then the stock market is likely to advance and we may have seen the bottom of the market falls. However, if a lot of companies do not at least meet their revenue and profit forecasts, then further falls in the stock market will likely follow. ASX-listed companies must report their financial results to shareholders at least twice a year but they can have different reporting periods. The next reporting season for majority of Australian companies occurs in August/September and the next round of GDP data is released in October. CPI and unemployment figures are reported on a monthly basis.

So how does all of this impact investment strategies going forward?

As there are so many factors involved in the economic machine it is next to impossible to predict market movements over the short-term. However, the current fall in stock prices has brought the value of companies to a more sustainable value and will, over the long-term, return to their pre-2022 prices. The key is to maintain a diversified portfolio of different investments and strategies and to avoid drastic changes based on fear. Regular re-balancing will also help to maintain your strategic asset allocation and possibly take advantage of market movements. Maintaining your investment plan and with regular contributions will ensure you reach your long-term goals despite the short-term setbacks. 

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Sofie Korac is an Authorised Representative (No. 400164) of Prudentia Financial Planning Pty Ltd, AFSL 544118 and a member of the Association of Financial Advisers.

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