Insights

Domestic Recovery Contests Global Shocks

Rapidly rising inflation has pushed the Fed to start hiking rates. While there has been less urgency from the RBA in Australia, rates will likely start to rise as wage growth begins to move higher. Moreover, despite the shocks from COVID-19 and the Ukraine War, Australia’s growth outlook continues to look positive which should remain supportive for equities although expect higher volatility.



The last few months have been tumultuous for the global economy. A surge in COVID-19 due to the Omicron variant put renewed pressure on the already stretched global supply chain and this disruption was made worse by Russia’s invasion of Ukraine. While the humanitarian impact on the people of Ukraine is undeniable – our thoughts are with everyone impacted – there have been global consequences. Global inflation was already surging before the war with many global central banks starting to withdraw stimulus and proactively start to tighten monetary policy.

However, the impetus to tighten has increased further with inflation in the US reaching levels not witnessed in 40 years. In mid-March, the Federal Reserve increased rates by 25 basis points, the first rate hike since 2018, marking the end of COVID-era monetary support. Higher rates are on the horizon – this is a shared theme globally, including in Australia, although the Reserve Bank of Australia (RBA) has felt that they can be patient. Australia is not seeing the level of inflation felt in other markets but inflation is rising.

The RBA, which ended asset purchases in February, has betrayed no urgency in regard to rate hikes. According to Governor Lowe’s March policy statement “The Board will not increase the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range. While inflation has picked up, it is too early to conclude that it is sustainably within the target range”. In the April statement however, the language around patience before raising rates has been removed signalling the potential to start hiking rates if they believe inflation reaches levels consistent with their target.

The labour market is essentially fully healed, the participation rate is high and wage growth is starting to move higher. The unemployment rate fell to 4% in February, which is the lowest rates since August 2008. Wage growth came in at 2.3% in 4Q21 on an annualised basis exceeding the pre-pandemic number but below the RBA target. While current inflation levels for prices and wages remain modest compared to the US or UK experience, inflation is moving higher from supply chain disruptions and higher input prices. Higher inflation, if sustained, is likely to feed through to wages. While the private sector continues to lead in regard to wage inflation, the uptrend is notable across the board. The data certainly supports RBA rate hikes this year, although we believe that the market is pricing in rate hikes which are far too aggressive. We expect the RBA to hike—probably twice—before the end of the year.

The macro data out of Australia continues to impress, and Australia’s 2022 prospects remain robust. We believe that there is little negative impact from the war in Ukraine. In fact, Australian materials sector looks to facilitate the global policy change of moving away from Russian commodities. Global and Australian equity markets fell following Russia’s invasion of the Ukraine on a pull-back in risk sentiment. However, most markets have already started to bounce back from their lows, including the S&P/ASX 200 Index which was up by 6.2% a month after the invasion.

How do markets tend to perform following the breakout of wars? We look at the historical index returns after the start of wars. To do this we focused on wars involving the US. There have only been two wars since the S&P/ASX 200 Index was launched. The table below highlights the performance of the S&P/ASX 200 Index after the Afghanistan War in 2001 and the Iraq War in 2003.

Figure 1: Index Returns Post-US Involved Wars

Afghanistan War (7 Oct 2001)
Iraq War (20 Mar 2003)
Period  S&P 500 Index S&P/ASX 200 Index S&P 500 Index S&P/ASX 200 Index
1-Month 3.97% 2.70% 4.44% 4.24%
1-Year -24.10% -6.36% 5.26% 18.37%
2-Years -15.97% 0.34% 4.34% 19.35%
3-Years -10.35% 5.16% 8.82% 21.15%

Performance data is calculated from first month end following the war beginning (Afghanistan War: 31 October 2001; Iraq War = 31 March 2003).
Source: Bloomberg Finance L.P. Returns over 1 year have been annualised.
Past performance is not a reliable indicator of future performance. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income as applicable.

In both cases, the S&P/ASX 200 Index has been resilient against exogenous shocks from wars although performance was weaker after the Afghanistan War in 2001. This is because the period of the Afghanistan War had another exogenous shock in the Tech-Bubble burst of 2001. In the last 80 years (1939-2020) the US has been involved in 7 wars. The S&P 500 Index generated an average of 2.18% a month after and an average of 9.87% a year after the breakout of these wars. This suggests that the post war performance in equity markets is driven more by the environment and economic outlook than the event itself.

The outlook for Australian equities looks positive over the near-term. Strong economic growth (we forecast GDP growth of 3.6% in 2022) has been feeding through into positive earnings growth. Financials, which account for about 30% of the market, are benefiting from the steeper yield curve, while the supply deficit from the global supply-chain disruption caused by the Ukraine war can be filled by the materials sector, which accounts for about 26% of the market. This should help to provide a further boost to earnings for Australian Equities.

Outside of the US, international markets have struggled in the wake of the Russian invasion of Ukraine and more hawkish central bank policy. While valuations appear more attractive, earnings expectations must come through for there to be a sustained recovery. Europe and Pacific equities are more exposed to the impacts from the war in Ukraine which have hurt earnings sentiment and price momentum. There is upside potential to the extent that geopolitical risks abate but near-term uncertainty is likely to feed into higher volatility.

On a relative basis we prefer US equities given a stronger macro outlook and expectations for a decent earnings season. However, higher inflation has increased the risks of policy mistakes, there is no clear path of resolution in Russia/Ukraine and concerns remain around Covid in China and the potential to exacerbate supply chain issues, all of which create near-term uncertainty and headwinds for risk assets.


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