Monday Espresso Podcast 20th September 2022

[00:00:00] Sheldon MacDonald: It is the 20th of September. I've been away for a week and I've come back to a rather gloomy picture. We've got inflation higher than expected. We've got markets sharply lower. We've got Sterling hitting a new low. Nathan, what's going on?

[00:00:14] Nathan Sweeney: Yeah, so actually a lot going on in markets last week, I think the key concern was around inflation. So we had an inflation data point, which was released in the US and that number came out above expectations.

[00:00:27] Nathan Sweeney: So basically the market was expecting inflation in the US to come out at 8.1% and it didn't, it came out slightly higher at 8.3%. This upset the market and you saw actually quite a heavy selloff in equities for the week, particularly US equities.

[00:00:44] Nathan Sweeney: Now the key point here is that it was the core inflation rate, which upset the market and core inflation separates out some of the volatile areas like energy and food and that number increased from 5.9% to 6.3%, but the interesting thing is that a lot of that has been driven by increases in shelter or housing and that's as a result of a lot of activity over the summer, as people try to refinance, remortgage, buy houses, in front of all of those rate rises, which we've seen, and that activity is already slowing, so you should see those numbers continue to fall because we did have inflation peaking during the summer at 9.1% and those numbers, even though they came in slightly higher are continuing to fall, so there is good news in there on the inflation side, if you look for that.

[00:01:35] Sheldon MacDonald: Yes, important to note inflation is lower, what the surprise was that it was higher than expected, last week. So still coming down, I guess, further positive news is that the oil price continues to trend slightly lower, down at $85 now.

[00:01:50] Sheldon MacDonald: Remember that peaked well over a hundred dollars some time ago so oil coming down will obviously help the inflation numbers.

[00:01:57] Sheldon MacDonald: All of the higher inflation numbers though, does raise the likelihood of higher rate rises coming through and with that higher expectations or higher likelihood of recession. So still a difficult outlook on that front.

[00:02:11] Nathan Sweeney: Yeah, so if we think about this week, we do have the Fed or the US central bank is meeting and they're expected to increase interest rates by 75 basis points or three-quarters of percent and that'll bring interest rates in the US up to 3.25%. So you can see that the Fed obviously still looking to increase interest rates to tackle inflation.

[00:02:37] Sheldon MacDonald: And also the BOE this week, probably a 50 basis point rate hike and we wait and see on that front. The other thing though that's starting to happen is we're starting to see earnings downgrades coming through. So analysts revising their forecast and we've seen those coming down.

[00:02:53] Sheldon MacDonald: That's also putting a slight damper on the mood in equity markets, again though, important to remember that the earnings expectations are still higher than last year, just, you know, less of an increase than had previously been expected.

[00:03:07] Sheldon MacDonald: All of this though, as I say, putting a damper on markets and we did see a big move down last week, importantly though, we are still above the June lows. So markets not collapsing totally and there's still some positives to be found in the current environment.

[00:03:22] Nathan Sweeney: Yeah and I think it's often at these points in times when markets tend to surprise you when all of that bad news is out of the way, that can be the catalyst for a positive outlook in markets.

[00:03:31] Nathan Sweeney: So just focusing on the earnings piece, companies were expected to grow their earnings in Q3 at about 9.8% and those earnings are being revised down.

[00:03:42] Nathan Sweeney: So we're now looking at 3.7% earnings growth they're being revised down because of increased costs for companies. So think about the increase in cost of financing, because interest rates have risen.

[00:03:54] Nathan Sweeney: However, as mentioned, you know, the positive takeaways are that it looks like things like inflation are falling and therefore interest rate rises, which are coming through should slow.

[00:04:05] Nathan Sweeney: Therefore that can be a positive catalyst for markets and markets tend to always look out about six months. What will the economy look like in six months' time they're less focused about today. That's all priced in.

[00:04:17] Sheldon MacDonald: The other positive that we've seen is that fixed income markets are indicating that perhaps things aren't quite as bad as feared, certainly credit markets not really reacting too much so credit spreads haven't blown out, really the credit markets showing that they still believe companies are in pretty good shape.

[00:04:35] Sheldon MacDonald: So some positives there. In terms of the environment, we've spoken about this before, we do expect volatility to continue. There's a lot of unknowns out there. Markets and investors wrestling with the idea of how high inflation will go. When will inflation turn? Will we see a recession? Won't we? What will happen to earnings?

[00:04:54] Sheldon MacDonald: All of these question marks as they remain, create this volatility. Anyway, despite all the doom and gloom, as we said, there are reasons to be optimistic. We do think we're closer to the end than the beginning. And we look forward to speaking to you again next week with a better market environment behind us.

[00:05:11] Sheldon MacDonald: Thank you very much. Cheers.

[00:05:13] Nathan Sweeney: Thank you.