A prominent economist has warned investors Australia has hit the end of a 40-year trend.
According to AMP Capital chief economist Dr Shane Oliver, current stock investor fears will be justified in the coming months as inflation rises up.
“Shares are at risk of a further near-term correction,” he said in a memo to AMP Ltd (ASX: AMP) clients.
“In the next few months, a further rise in inflation will likely push bond yields higher which may further threaten shares (particularly tech stocks which are vulnerable to higher interest rates).”
But the good news is that this won’t last long.
“While the risks have increased, we are of the view that the inflation spike will prove temporary,” said Oliver.
“There are some very tentative early signs of this with some commodity prices rolling over… semiconductor chip prices trending down and business surveys showing a decline in the ratio of new orders to inventories. There is a long way to go before this is confirmed though.”
A very long deflationary era is now ending
In a longer-term timeframe, OIiver warned investors the world was now at the end of a multi-decade trend.
“We’re likely now going through the bottoming of the long-term decline in inflation that has been in place since the early 1980s,” he said.
“Many of the factors that drove the declining trend in inflation since the early 1980s are now fading.”
After years of struggling to get inflation up, the COVID-19 downturn has given central banks the impetus to be more aggressive.
“The shift from focusing on forecasts to actual inflation means central banks will be slower to raise rates — allowing inflation to rise further. And massive quantitative easing is now being combined with fiscal stimulus which provides an avenue for easy money to boost spending (unlike last decade when fiscal austerity offset easy money),” said Oliver.
“This likely constitutes a ‘regime shift’ in the approach to [boosting] inflation – much like the aggressive approach to keeping inflation down led by the Fed from the early 1980s was a ‘regime shift’.”
Oliver also observed that both the pandemic and the political climate has put globalisation into retreat, leading to less competition.
“We’re seeing a trend to bigger governments and that can ultimately be associated with lower productivity growth,” he said.
“The ratio of workers to consumers is declining in many countries which may drive higher wages growth and lower productivity growth.”
How will this affect share markets?
Oliver’s view that the inflation spike will be short-lived bodes well for equities in the near-term.
“Cyclical bull markets usually don’t end until excesses build, central banks tighten aggressively, and this drives a collapse in earnings. But this still looks a long way off,” he said.
“As a result, we remain of the view that share markets will provide solid gains over the next 12 months.”
The zero-interest environment that drove growth’s winning streak the last 12 years will “start to fade”, said Oliver, and investor returns will more closely correlate to “underlying yields and earnings growth”.
“Inflation around target is the best scenario as it would still mean low inflation – but less risk of deflation and likely higher wages growth (which is positive in terms of social stability, rising living standards and equality). And investment returns would still be okay.”
The pessimism for growth stocks matches the findings from a recent Vanguard study.
“We expect value to outperform growth over the next 10-year period by as much as 5% to 7% per year, and perhaps by even more over the next 5 years,” read the paper titled Value versus growth stocks: The coming reversal of fortunes.