Tech stocks and ETFs out, Mining stocks in as US inflation hits a new high

In world markets (as in most things) Australia is a passenger rather than a driver. And that’s not always bad, especially when you're talking about the US Fed's latest inflation figures. 

US inflation is currently higher than Fed chairman Jerome Powell would like, Thursday’s annual reading of 7% for 2021 showing the sharpest uptick since 1982. This will likely accelerate interest rate rises, as shown in the latest dot-plot chart that illustrates the Federal Open Market Committee members’ views on where rates need to be over the next few years.

As the COVID Omicron variant continues to disrupt the economic recovery of global markets, including Australia, the goalposts are shifting again. And from last year’s seemingly endless discussion about whether rising inflation would be transitory or structural, it’s now a question of how quickly monetary policy is tightened. I spoke briefly with AMP’s chief economist Shane Oliver and Henry Jennings, senior analyst and portfolio manager at Marcus Today about what this means for Australian investors.

In Australia, inflation currently sits at around half that of the US. This is partly because of differences in our consumer pricing index, which in the US also factors in the cost of housing (or “shelter”). “If you included that in ours, the number would be pretty catastrophic too,” says Jennings.
“Our inflation figure is nowhere near as high as in the US, but the RBA is definitely going to have to raise rates. It’s just a question for us – as in the US – of how quickly rates are pushed higher.”

Jennings emphasises that Australia’s interest rates already sit at emergency settings. The money pushed into the economy by our central bank to keep it afloat amid lockdowns and other measures to slow the spread – at least before January – has distorted things.”

“At some stage, we’re going to normalise, but the RBA will do it cautiously. At the moment there’s a lot of kite-flying out there – though with the RBA on holidays we haven’t seen much here – but the RBA doesn’t have the same impact as the Fed,” Jennings says.

“We know the RBA’s going to move but it’s not going to be the end of the world for our market, just some adjustments and rotation.”

Will the RBA lift rates faster?

AMP’s Shane Oliver says the worry for the US economy is that if the Fed doesn’t slow inflation soon, current levels could become entrenched. In line with this, he expects US rates will be lifted again in March, the first of four or five over the course of 2022. “And by the end of the year we may start to see some Quantitative Tightening, reversing some of the QE they’ve done,” he says.

Oliver’s expectation for when Australia lifts rates remains unchanged, looking for the first rise in November or December. This is earlier than the RBA’s latest view of 2024, or possibly 2023, from last November.

“Consensus is more like 2023 from economists but the money market has been factoring in rate hikes for this year. It’s really only the Fed where the timing has been brought forward,” Oliver says.

“The feeling was that the US would start raising in the June quarter, now it’s March, a few months earlier than expected.”

The likes of Bloomberg have started referring to the US national balance sheet as “bloated” in alluding to the Fed scaling back its US$120 billion a month bond-buying program by around US$15 billion in the backend of 2021.

“The Fed announced an acceleration in the taper at the December meeting, so I think that rate of bond-buying is due to end in March. But it’s quite possible, given the inflation risks, that they’ll end it at the back of January, when they next meet. And at some point, they’ll start doing QT,” Oliver says.

Australia’s headline inflation figure of 3% currently is elevated “but not particularly high,” he says. And the news about US lifting rates faster and sharper than previously anticipated shouldn’t blindside local investors, given the inflation rhetoric that dominated last year.

“The pickup in inflation here hasn’t been anywhere near as significant as in the US. We went through many generations of low and falling inflation which enabled asset prices to stay low.

“If we’re coming into a world of higher interest rates it’s going to be a bit of a constraint. It looks like the music might be changing and it’s likely to be a big constraint on house prices.

“It’s just another thing to keep an eye on. The period of falling interest rates is probably behind is, so you should get used to the idea of rising interest rates which will impact the share market.

Jennings believes interest rates in Australia could rise as early as March: “The RBA may warn in February, go in March and do another rise in April then see what happens.”

The looming Federal Election further complicates things locally as does the ongoing uncertainty of Omicron and other potential coronavirus variants.

“But the market has been quite relaxed, not quite sanguine, on the news of four rate rises in the US and what it could mean for Australian rates,” Jennings says.

What this means for Australian investors

Jennings' view is that a little bit of inflation and the accompanying rate rises isn’t a bad thing, but you should probably avoid loading up on ETFs. “For retail investors we’ll see more volatility this year, with careful stock selection likely to be much more important in 2022 than it was last year,” Jennings says. 

Oliver believes technology stocks will come under increasing pressure, which we’ve seen in the US in recent days, the S&P 500, Dow Jones, and NASDAQ down 1.4%, 0.5% and 2.5% yesterday.

“That’s just one night, it doesn't prove anything, but generally speaking tech stocks have started to unwind. The trick for investors is to look for stocks that have protection against higher inflation – materials and other cyclicals will probably benefit more," he says.

“Even banks might do better because they like higher interest rates. Whereas tech stocks and some of the yield plays such as REITs and Utilities should come under pressure.”

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