Uneasy in ’23 with Bassanese: Earnings outlook stormy, but with a hint of an RBA rates rainbow out there in the beyond
BetaShares chief economist David Bassanese has provided his Australia economic 2023 outlook, which looks like a bit of fire and a bit of ice for all involved.
The theme for this year has been global central banks getting serious about tackling inflation and hiking interest rates.
In Australia the RBA raised the cash rate by 25bps to 3.1% at its December meeting. It was the central bank’s eighth straight rate rise since it started lifting the cash rate from a record low of 0.1% in early May and is now at its highest level in a decade as the RBA has worked to contain inflation.
“Central banks lost patience with inflation falling of its own accord and economies have so far been pretty resilient to the rate rises,” Bassanese told Stockhead.
“The initial expectations for policy tightening at the start of the year have had to ratchet up over the course of the year.”
While rising interest rates, economic resilience and falling equity valuations were the story of 2022, Bassanese said slowing economic growth, declines in bond yields and corporate earnings is the narrative for the Australia economic 2023 outlook.
“In terms of equity markets all of the adjustments so have been with PE ratios coming down so valuations have been crunched down as interest rates go up but the resilience of the economy have meant earnings haven’t really fallen,” he said.
“The story of next year might well be that interest rates are no longer the drag on the market and that corporate earnings will take that mantle, which may leave equity markets under downward pressure.
“Earnings are likely to be the drag on the market at least for the first half of the year.”
Bassanese said while growth has been strong in Australia with a tight labour market, the RBA wants to see it slow though ideally while avoiding a recession. In the US stronger wage growth means the US Federal Reserve appears even more willing to risk a recession to get inflation down.
“Central banks are gunning for growth to slow and if it doesn’t they will just keep on raising rates so basically it will be a continuation of this year until such time as growth finally does capitulate in the face of higher rates,” he said.
“I do anticipate that central banks will ultimately win their battle and economies will capitulate.”
The word recession can be enough to send a shudder down the spine of many investors. In the US the National Bureau of Economic Research determines when the US is officially in recession.
“Historically, every time the US unemployment rate has gone up by at least half a percent it has typically triggered a recession,” Bassanese said.
“The US Federal Reserve is already forecasting a greater than 1% increase in unemployment rate next year.”
With the US unemployment rate at 3.7%, close to historic lows, it is too low to get wage inflation down.
“It needs to go higher and that’s why more and more people are signalling a likely recession in the US.”
A recession is technically defined as two consecutive quarters of negative GDP growth, so all you need is GDP to fall for two quarters and then you have a recession.
“By recession in Australia I mean an increase in the unemployment rate of more than 1.5% that’s probably a recession regardless of whether you get two quarters of negative growth and that would be my definition,” Bassanese said.
“You can get a negative quarter and then the economy bounces back a bit before another negative quarter but I think a better measure is to focus on the unemployment rate.”
Bassanese said the RBA is pretty much off the hook with orchestrating a recession in Australia.
“The problem is if the US goes into recession you tend to see businesses around the world hunker down, investment decline, employment demand decline,” he said.
“Historically, every time the US has gone into recession more often not we have had an increase in the unemployment rate of at least 1.5% so on that measure we will succumb to a recession of sorts.”
Bassanese said an Australian recession may in turn lead to the RBA cutting interest rate cuts.
“We may see rate cuts in the second half of the year to counteract what flows through to Australia from the US.”
Bassanese said we are living in a world where labour markets are too tight, which will be the challenge for equity markets next year.
He said areas which will probably do best will be the defensive sectors such as consumer staples, healthcare, utilities and infrastructure, while consumer and resource stocks may come under pressure.
“Resources have held up alright this year because the global economy has been resilient and energy prices have increased due to the Russian-Ukraine war,” he said.
“But if you do get a US recession then commodity prices should generally speaking come off. ”
However, he said the reopening of China and/or an escalation of the Russian-Ukraine war could see energy prices – including oil – potentially rise, which would complicate the outlook for central banks.
“There is a risk oil prices rebound next year because of the Chinese re-opening plus the US can’t run down its strategic oil reserves any further,” he said.
“The US haven’t been tapping demand as much as you think because of the decline in their oil reserves but now they’ve run low and they’re looking to restock.”
He said if oil prices do bounce back next year central banks could be more aggressive for longer.
And while Bassanese may have provided what seems like a pessimistic Australia economic 2023 outlook he said it is worth remembering we have just reached the end of an economic cycle.
“The US unemployment rate is under 4%, while wages growth is running at over 5% so growth must slow to rebalance the economy,” he said.
“We were facing this before covid when the US unemployment rate was also low, wages growth was picking up but just as we started to worry about that covid struck.
“We are now back to where we were in 2019 though with arguably even less spare economic capacity.”
This year saw an unusual economic phenomenon where both bonds and equities fall simultaneously.
There’s normally an inverse relationship in bonds and share markets. When there’s prolonged price declines in equities, bond prices generally rise as investors seek a safe haven, but that didn’t occur the latest market drawdown.
“When central banks aggressively raise interest rates it hurt bonds but also equities,” he said.
“But next year if growth slows and central banks can sit back and not raise rates then bonds will do better.
“Bonds are looking attractive in a US recession scenario so that is at least some salvation for investors.”