Monday Espresso Podcast - 12th June 2023

[00:00:00] Sheldon MacDonald: It is the 12th of June. We've all been preoccupied with the prospects for recession versus growth this year, and interest rate markets and expectations for inflation. So let's just stop and pause for a second and see where the market is thinking we're going. At the moment, we're still seeing a consensus, 65% chance that there will be a recession, at least in the US within the next 12 months.

[00:00:25] Sheldon MacDonald: But we have seen those expectations coming down recently and we've got players such as Goldman Sachs. Yes, they are eternally optimistic, but they put the chance of a recession as low as 25%. So we've seen this change, people starting to expect perhaps things might not be as bad as previously feared.

[00:00:43] Sheldon MacDonald: With that though, has come changes in interest rate expectations. So we've got an FOMC meeting, so the US Fed meeting to decide on interest rates this week, and all the talk is, will they, won't they? Will we see a raise? Won't we see a raise?

[00:00:57] Nathan Sweeney: Yeah. So this is quite interesting. So if we look at, over the course of the last year, we've had severe inflation.

[00:01:04] Nathan Sweeney: That inflation is now starting to come down. What we've really seen is that the economy generally, globally has been quite resilient in the face of all these interest rate rises. But the reality is, is that central banks are now really close to the peak in raising interest rates. So if we look at the Fed as an example, they've raised interest rates for the last 10 consecutive meetings, and that this week could be the point where they pause their interest rates.

[00:01:31] Nathan Sweeney: So quite a significant moment for markets.

[00:01:34] Sheldon MacDonald: Markets expecting by the end of the year, perhaps 70% chance of one further rate hike of 0.25%. But really as you've said, the expectation this time around in this month, about a 70% chance that we get no hike. So as you say, the chance for a pause and reflect.

[00:01:54] Sheldon MacDonald: Now, while that might be hawkish on the interest rate side, it's actually pretty positive for equities. The reasons why the interest rate expectations are coming down is that the economy has actually been pretty strong, growth stronger, no recession, the jobs market, yes, some weakness there, but generally pretty strong still.

[00:02:13] Sheldon MacDonald: If the jobs market is strong, consumption remains strong, and consumption drives 70% of the economy. So pretty positive picture emerging for the economy, at least in relative terms and what that has meant, as I said, is a positive story for equities and we are now in bull market territory for the S&P.

[00:02:31] Nathan Sweeney: Yeah. So what is a bull market you might ask? So a bull market is just when the market rises by 20% or more and normally when you get that 20% rise, it is a sign that things can continue to go up.

[00:02:44] Nathan Sweeney: So if we just reverse a little bit, you know, the market started to fall back in January 2022, and then it bottomed, and this is looking at the US market in October the 12th 2022, and it's been rising steadily since, and a lot of people haven't been aware of that because they've been focused on all the pessimistic news from interest rates rises and falling house prices.

[00:03:07] Nathan Sweeney: But on the sidelines, markets have actually been doing quite well and we're now in this position where it's been called a bull market, and that could be a real change in direction for markets from here.

[00:03:19] Sheldon MacDonald: Of course, though that bull market has been driven pretty narrowly by the big growth stocks. What we just saw last week was perhaps maybe the first inkling of the broadening of that growth driver.

[00:03:30] Sheldon MacDonald: We saw the Russell 2000, which includes small-cap stocks. That was actually the top performing market last week up 1.9% in the US. So perhaps are broadening out on some opportunities beyond just the mega-cap tech names.

[00:03:44] Nathan Sweeney: Absolutely. And another interesting thing to point out is usually when you get a bull market forming, it can be really good for small-cap stocks.

[00:03:52] Nathan Sweeney: So across various different regions you can see that small caps are starting to do a lot better because obviously if interest rates peak and start to come down, that's gonna help the financing for these smaller companies, as in financing costs will be lower and therefore you start to see a reversal in the performance, and we're beginning to see that again.

[00:04:10] Nathan Sweeney: So some interesting change in dynamic happening at this point in time.

[00:04:14] Sheldon MacDonald: Now, we spoke last week around the oil price. We'd had an OPEC meeting and Saudi Arabia was indicating that they were gonna cut production, and we feared that that might push the oil price up and lead to a second bar to inflation. So far though, this week we've actually seen little change in the oil price.

[00:04:31] Sheldon MacDonald: So what's happening there is fears of lower demand for oil and a lot of that is being driven by weakness in China. So inflation has been pretty low in China, but also the growth outlook in China is pretty low. Some relatively weak follow through of the post covid impetus that we expected.

[00:04:53] Nathan Sweeney: Yeah, you know, the property market's been quite sluggish as well, and then you also have high youth unemployment, so it's kind of really disappointed investors this year who were expecting more from that region.

[00:05:04] Sheldon MacDonald: Now let's look at the week ahead. We've got, as we mentioned, the Fed in the US deciding on interest rates. We've also got the European Central Bank making a decision. They're expected to raise rates by another 0.25%, and the Bank of Japan looking to make a decision as well. Now, Japan has been in the news recently, some commentators indicating that it's undervalued, that it's ripe for some growth, and we've seen strong flows into Japan.

[00:05:30] Sheldon MacDonald: So perhaps that's going to become a talking point in the months ahead. As always though, lots going on and we look forward to speaking to you again next week.