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Inflation blowout is last nail in the coffin of the pandemic share market: Editor's Note

Emma Rapaport  |  30 Apr 2022Text size  Decrease  Increase  |  
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$2 a litre for petrol. An extra $20 on the grocery bill. We've all felt prices increases, but this week we got confirmation that inflation has landed. Over the last year, the average prices on a basket of goods tracked by the Australian Bureau of Statistics have risen by more than 5%, the highest levels since the GST was introduced in 2000.

It will surprise no one that petrol prices top the list, jumping 35% from mid-pandemic lows. Prices for new dwellings are also up 13.7% over the year thanks to strong demand for materials and labour supply disruptions. And as a journalist with an unhealthy coffee addiction, I couldn't help but notice that ‘coffee, tea and cocoa’ is up a staggering 6.9% just in the last quarter and 'dairy and related products' saw a 1.9% increase.

Many economists and analysts now expect the inflation blowout sets the scene for the RBA increase the cash rate when it meets next week - election be damned. The bank's preferred metric — which strips out the biggest price rises and declines — is well above their target band of 2% to 3% for the first time in a decade. Most are pricing in a series of increases to north of 1% by year-end. As someone who got into the housing market in 2020 under the impression interest rates wouldn’t rise until “at least 2024”, I feel particularly stung by this violent turn of events, but that’s my own beef with the Governor. 

Rising rates have broad-reaching impacts on earnings and help tip the balance away from the ‘growthier’ ends of the market that have thrived since the pandemic. We're already beginning to see the effects in the US, which is months ahead of us in terms of inflation. As my colleagues Lauren Solberg and Jakir Hossain wrote this week, stocks suffered renewed declines in April that left broad market benchmarks flirting with their lows for the year amid signs the Federal Reserve will be even more aggressive in raising interest rates.  Big-name technology and communications stocks such as Microsoft (MSFT), Apple (AAPL), and Nvidia (NVDA) led the broader market 8% lower, bringing the year-to-date declines to just under 13%, while value names provided some shelter from the storm.

While these macroeconomic dynamics have been building (and anticipated) for months, I think it’s important we recognise the impact of this week’s numbers on consumer and investor psyches. So much has shifted in the last six months. Fortunes have changed for pandemic winners as high-flying tech stocks continue to fall and maligned energy and industrial names remain at the forefront. Last year’s top fund performers are this year’s losers, and vice versa as value managers who suffered through a decade of growth stock outperformance finally have good news to share. And incredibly, long-term bond yields back above 3% are opening opportunities in the bond market not seen since 2014.

MORE ON THIS TOPIC: Now you can earn 5% on bonds but stay with quality

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For some, this moment presents an opportunity. Broker nabtrade reported that trading volumes spiked 50% following Tuesday’s 2% fall on the ASX, with the materials sector a favourite among investors enjoying the surge in commodity prices. For investors looking to put their money to work, US stocks covered by Morningstar analysts are now the cheapest they’ve been since the pandemic driven bear market. Locally, we’ve recently highlighted two undervalued ASX-listed stocks – Ryman Healthcare and TPG – and the list of four and five-star stocks is growing.

US market falls into undervalued territory for the first time since the pandemic: Morningstar

Market valuations

Writing in Firstlinks this week, VanEck’s Russell Chesler expects the Australian market, dominated by miners and value shares like the big banks, to outperform the US amid higher commodity prices. Financial Services (26.5%) and Basic Materials (25.2%) account for just over half of Australia’s S&P/ASX 200 following the BHP unification. Healthcare at 8.8% sits in third place, while Energy is 9th with a weighting of 4.3%. Reflecting the major difference between the US and Australian benchmarks, the Technology sector ranks second last at just 3.7% The S&P 500, on the other hand, has a 28% weighting in the IT sector.

But markets remain exposed to a growing number of risks. There’s the slowdown in global growth (the IMF downgraded global growth forecasts last week), the end of easy monetary policies (can the Fed engineer a soft landing?) and intensifying supply chain disruptions from China’s lockdown of its twin economic engines, Beijing and Shanghai. Sourcing material from Europe will also be fraught as the bleak energy supply position impacts manufacturing schedules and Russia weaponises gas supplies.

A word of advice from Morningstar’s Peter Warnes in Your Money Weekly: “Remain alert and vigilant as volatility will present opportunities”. He also urges investors to put company profits back on the agenda as interest rates begin to ratchet upward. “In a zero-interest rate environment, time was on the side [of unprofitable companies]. But rising interest rates will dampen consumer demand, lift interest expense, squeeze operating margins, and drive bad debts higher. The market’s patience has worn thin, and the previous gloss is now tarnished."

More from Morningstar this week:

Aussie equities have little to fear from rising rates

We popularised moats; Here's the verdict 20 years later

Buffett and Berkshire in 2022

Tesla shares crash on market concerns over Twitter deal: Analyst view

Bill Browder: A scared Putin will only escalate the conflict

is the editorial manager for Morningstar Australia. Connect with Emma on Twitter @rap_reports. You can email Morningstar's editorial team editorialAU[at]morningstar[dot]com

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