Knowledge hub

Staying the course | Financial markets now predict a soft landing!

Back to insights

By Capital Partners Markets and Investments

At the start of this year, most market commentators were convinced that the US – and indeed Australia – would enter a recession this year. According to the so-called ‘experts’, market measures persistently reinforced the view that the sudden increase in interest rates would cause a hard landing, resulting in central banks having to subsequently cut rates as early as the end of this year to get the economy moving again.

If you took action on this narrative, then you would have followed the path to get out of equities and load up on cash or bonds. After all, if the economy is going to go into recession, then surely stocks will tank, and if interest rates are going to start coming down in the near future then bonds are going to rally – all makes good sense, right?

But the dreaded recession – while it still may happen – hasn’t occurred yet. Since the start of the year, the US market[1] is up 22% (in AUD), and the World ex-USA index is up 16% (in AUD). The chart below shows the daily performance of the three indices since the start of the year.

Meanwhile, the highly anticipated rally in bonds is yet to materialise. Many economists and commentators felt that the “terminal rate” – peak interest rates – were very close and that bond yields would not go any higher. Furthermore, they believed that once the economy sharply contracted due to the fastest rate rises in modern history, then central banks would need to bring rates back down again to get the economy moving.

This view seemed to be vindicated in the first quarter of 2023, when Silicon Valley Bank became insolvent. Its collapse, the collapse of several other smaller US regional banks, and the turmoil surrounding Credit Suisse Group spurred a frantic rush for safety, evoking memories of the GFC. Volatility gripped global markets and yields on bonds fell dramatically as the likelihood of global recession increased. But, like many times before, those banking stresses faded into the background, and measures of risk, such as volatility, receded.

However, there are warnings that the job of beating inflation is far from over. Data shows that while inflation is coming off its highs, the economy is still growing at a faster-than-expected pace. The chart below shows bond yields have continued to edge higher on the expectation that the challenge has not yet been won.

 

The US yield curve still shows an inversion, but the sharp increase in long-term borrowing rates relative to short-term rates means bond investors now believe the world’s largest economy is likely to have dodged the feared hard landing as policymakers near the end of their tightening cycles. In plain terms this means the market has increased the odds of a soft landing.

It may well be premature to declare victory over inflation and that a recession is now off the table. There are still risks that inflation proves sticky and rates may rise again. It could be that a recession will take longer this time to eventuate. Everyone agrees that both the US and Australia will see a slowing in their economies – this is already happening – but with the current economic resilience, and inflation coming off, there may be no need to cut rates this year or next.

What does all this mean for investors? It means that no one knows for sure whether we will have a hard landing or a soft landing, and certainly no one knows what either outcome means for the equity or bond markets. Ultimately the best course of action for investors is to ignore the constant news cycle that reports on every inflation number and interest rate rise as if it can determine the future for their portfolio.

What does matter to investors is staying the course. Making the trade at the start of the year to get out of equities and load up on bonds seemed like an obvious course of action, but with hindsight, it would have been disastrous for your portfolio. The best trade is to tune out the financial media noise and stay the course in a well-diversified portfolio that has been created to meet your needs.

 

[1] Indices used are the MSCI USA Index (in AUD), MSCI World ex-USA Index (in AUD), Bloomberg Global Aggregate Bond Index (hedged AUD). Date range 1-Jan-2023 to 15-Aug-2023.


Dr Steve Garth PhD, M.App.Fin., BSc., BA. is the Principal of Principia Investment Consultants and works with Capital Partners assisting with communications.

For nearly two decades, Steve played a key role in helping grow the Australian arm of a global asset manager. During his career he managed Australian and global equity portfolios, managed the Asia Pacific trading team and for the last 10 years he managed the firm’s fixed interest strategies.

Steve received his PhD in Applied Mathematics from the Australian National University. He also holds a BSc in Mathematics and Physics, a BA with majors in History and Politics, a Master of Applied Finance.

 

The information provided on this site is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different and you should seek advice from a financial planner who can consider if these strategies and products are right for you.

Ideas & insights

Knowledge Hub

The evolution of AI and its implications

Lifestyle • Article