ASX shares are "vulnerable" to a correction in the coming months, but investors with patience could benefit towards the end of this year.
That's the warning from AMP Ltd (ASX: AMP) chief economist Dr Shane Oliver, who urged punters to stick to a long-term investment strategy.
"From their lows last year, global and US shares are up 17% and Australian shares are up 13% as investors have been buoyed by evidence of peaking inflation," Oliver said on the AMP blog.
"This has resulted in solid year to date returns. But is it sustainable?"
The bad news
Oliver feels negative about the short-term fortunes of the stock market for multiple reasons.
Firstly, the market gains this year have come from a very narrow set of stocks.
"So far this year, AI related stocks have accounted for all of the rise in the S&P 500 Index (SP: .INX), with the Dow Jones Industrial Average (DJX: .DJI) actually flat year to date."
Another big fear is the prospect of recession in the US and elsewhere.
"Leading economic indicators are continuing to point to a high risk of recession," said Oliver.
"A recession would mean a sharp decline in company profits, which is not currently expected by the consensus."
Over in the US, the banking sector continues to be under stress while in China, the post-COVID economic recovery has been underwhelming.
"In particular, it's concentrated in services as opposed to manufacturing. This may mean less of an impetus for global growth."
Commodity prices are soft this year. This is a negative for the resources-heavy S&P/ASX 200 Index (ASX: XJO), which has underperformed compared to other markets.
"Weakness in copper, oil (despite OPEC production cuts) and other industrial commodities suggests weakening demand," Oliver said.
"This is also being reflected in the growth-sensitive Australian dollar which recently broke below support at 66 US cents."
Even though central banks are nearing the top of their interest rate curve, they "remain hawkish" and are risking "overtightening".
"In Australia, continuing hawkish commentary from the RBA with risks around wages, poor productivity growth and rising home prices, which are reversing the negative wealth effect," said Oliver.
"All this means that the risk of further RBA rate hikes is very high. Further rate hikes will exacerbate the economic downswing and add to the already high risk of recession."
The good news
But if investors look longer term, there are some positive forces around the corner for ASX shares.
According to Oliver, inflation seems to have passed its peak.
"Business conditions PMI [purchasing managers' index] surveys show a continuing downtrend in input and output prices for manufacturing and services," he said.
"Order backlogs are well down from their 2021-22 highs and delivery times are much improved. At the same time, labour markets are gradually becoming less tight with slowing job openings."
Other statistics in both Australia and the US show "a further decline" in inflation, perhaps pointing to some relief for everyone towards the end of this year.
"If correct, this will provide scope for central banks to ease monetary policy later this year or early next."
Another positive is that so far, globally, economies have fared better than feared.
"In fact, business conditions according to purchasing manager surveys have improved since late last year, suggesting growth will surprise on the upside," said Oliver.
"So far company profits globally have held up better than expected."
And, believe it or not, the spectacular rise of artificial intelligence into the mainstream is a massive long-term tailwind for ASX shares.
"Enthusiasm for AI has the potential to push share markets higher directly in terms of IT stocks that will benefit from related demand associated with an upgrade to AI, but also via a productivity boost to high labour industries," said Oliver.
"Of course, as we saw with the late 1990s tech boom, the benefits could take time to materialise and investor interest could get frothy, setting up a short-term pullback."
Keep your head
So with such mixed fortunes coming in the next year, Oliver urged investors to bunker down for the long term.
"It's very hard to time market moves so the key is to stick to an appropriate long-term investment strategy," he said.
"Australian shares still offer attractive income versus bank deposits… To avoid getting thrown off a good long-term strategy, it's best to turn down the noise around all the negative news flow."
Fluctuations in ASX shares are stressful but ultimately "healthy and normal", he reminded.
"Their volatility is the price we pay for the higher returns they provide over the long term… Share pullbacks provide opportunities for investors to invest cheaply."
