The stock market has rallied hard in 2023, but investors need to be wary that they could cop a punch to the face before the year is over.
That's the opinion of AMP Ltd (ASX: AMP) chief economist Dr Shane Oliver, who warned that a recession is more likely than you might think.
"Rapid monetary tightening points to a high risk of recession and, given lags in the way it impacts the economy, just because it hasn't happened yet does not mean it won't," Oliver said on the AMP blog.
"We remain of the view that shares will do well on a 12-month horizon, but the risks around recession and higher bond yields mean that the risk of a correction is high."
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Delayed impact of rate rises is 'a high risk'
Indeed the S&P/ASX 200 Index (ASX: XJO) has risen 5.64% so far this year, while those Australians with US shares have done even better, seeing the S&P 500 Index (SP: .INX) rocket 16.8%.
Oliver is concerned that this has lulled many investors into a false sense of security.
"It's a high risk with the lagged impact of [interest] rate hikes still feeding through – particularly in Australia where we put the risk of recession at 50% given the vulnerability of the household sector," he said.
"Weak growth in China is also adding to the risks of recession."
There are several ways Australia can still avoid a recession though, but everything needs to go right.
"First, inflation could fall fast, taking pressure off rates. Second, there is a lack of excess to unwind," said Oliver.
"Third, households still have pandemic savings buffers."
The other possibility is that rather than an economy-wide recession, the country could experience rolling contractions within certain industries.
"Various sectors of the economy may have 'recessions' but at different times such that the overall economy never actually contracts," Oliver said.
"Something like this happened through the 1990s and 2000s to varying degrees providing support for the view that the environment back then was characterised by micro instability but overall macro stability and hence milder economic cycles."
Good news is bad news
Ironically, both the economy and stock markets will be in jeopardy if a growth revival is seen before inflation has time to land back to comfortable levels.
"This would be a problem as it would likely mean a further fall in unemployment and so even tighter jobs markets, more upwards pressure on wages growth, higher for longer inflation and central banks keeping interest rates high for longer or even raising them further — to the point where recession comes anyway."
This scenario has been a worry for financial markets over the past couple of weeks, pushing up the bond yields.
"[This] has in turn has pressured share markets as higher bond yields make investment in shares look less attractive."
In positive news for long-term investors, despite the immediate anxieties, Oliver believes shares will make a comeback over the next year.
"We remain of the view that shares will do well on a 12-month view, but the risks around recession and higher bond yields mean that share market volatility will remain high with a high risk of a correction."
