The latest jobs data and rising oil prices have raised the spectre of a new and significant threat to the two-year bull run that has delivered a near 30% gain on the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) – and that’s before dividends and franking credits. But just as investors are getting comfortable with stretched valuations, geo-political tensions and US President Donald Trump’s tweet-bombs, a big new risk factor is brewing on the horizon. This threat is the dreaded stagflation syndrome, an economic term used to describe low or no growth and rising inflation. This risk isn’t on the radar of most…
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The latest jobs data and rising oil prices have raised the spectre of a new and significant threat to the two-year bull run that has delivered a near 30% gain on the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) – and that’s before dividends and franking credits.
But just as investors are getting comfortable with stretched valuations, geo-political tensions and US President Donald Trump’s tweet-bombs, a big new risk factor is brewing on the horizon.
This threat is the dreaded stagflation syndrome, an economic term used to describe low or no growth and rising inflation.
This risk isn’t on the radar of most experts, and I wouldn’t describe it as being one of our most probable risks, but last week’s job data in cementing our economy in a low wages growth environment shows this risk is closer than you might have thought.
This is particularly so if you consider where oil prices and the Australian dollar have headed recently.
Crude prices have surged by close to 80% over the past year, while the Aussie has been backpaddling since hitting a high of over US81 cents in February to trade around US75 cents.
While the Reserve Bank of Australia’s (RBA) core inflation reading ignores volatile commodity prices, the outlook for both crude and the local currency means the upward price pressure from these inputs will flow though to the broader economy.
Households are already starting to feel this at the pump and you should be prepared to pay more for just about all your purchases as our economy is highly reliant on trucking things around the country.
My view stands in contrast to the belief held by many that our economy is in a sweet spot, with a mildly accelerating economy and benign inflation due to the lack of wage pressure.
Wage growth is a key driver for inflation, but it isn’t the only driver. You only need to look at comments from several companies complaining about rising input costs, such as James Hardie Industries plc (ASX: JHX) and CSR Limited (ASX: CSR), to see early evidence of this.
Oil isn’t the only commodity that’s forecast to rise either. Analysts are expecting buoyant metal prices to hold on to gains or to keep climbing higher in 2018 or 2019, due in part to a stronger US dollar (and that means a weaker Aussie).
I think inflation is a bigger threat than most think, particularly if it isn’t supported by higher wages as that will erode the spending power of households.
Against such a backdrop, it’s hard to see how forecasters will not be dialling back their growth forecast for the Australian economy.
Low growth and higher inflation is bad news for just about every sector on the market. Big banks like Commonwealth Bank of Australia (ASX: CBA) that are already under pressure from a slowing housing market will be hit hard, as will discretionary retailers like Myer Holdings Ltd (ASX: MYR).
Resource stocks like BHP Billiton Limited (BHP), Rio Tinto Limited (ASX: RIO) and Woodside Petroleum Limited (ASX: WPL) will fare better thanks to higher commodity prices and their cashed-up balance sheets.
Defensive infrastructure stocks that have been under pressure from rising bond yields could also come back into favour if the threat of stagflation rises. This includes Spark Infrastructure Group (ASX: SKI) and APA Group (ASX: APA), more so than Sydney Airport Holdings Pty Ltd (ASX: SYD) as the airport operator is more exposed to economic cycles than power and gas utilities.
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Motley Fool contributor Brendon Lau owns shares of BHP Billiton Limited and Rio Tinto Ltd. The Motley Fool Australia owns shares of and has recommended Sydney Airport Holdings Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.