Are we heading into an economic recession?

Hi everyone,

Well, that was some send off from Sunrise this morning! Now off to a big lunch to celebrate.

But first, my wrap of the most important money, investment and economic news you need to know this week.

I reckon the chances of Australia going into economic recession have increased significantly because of Tuesday’s rise in interest rates — caused by Federal Treasurer Jim Chalmers.

Why?

I remember back in 1990 when then Federal Treasurer Paul Keating said the economic crunch was “the recession we had to have”.

Current Treasurer Jim Chalmers is an economic disciple of Keating, so I’m wondering whether he is steering us into another “recession we have to have”.

Because this week’s interest rate rise from the Reserve Bank is on Jim Chalmers.

The RBA has constantly said that that any rate rises would be driven by the economic data, which has been really soft. Retail sales are flat, building approvals have collapsed, the wage price index for the March quarter was slightly less than expected, unemployment is rising and Wednesday’s economic growth was less than expected.

All the economic indicators are turning down, the economy is slowing… all good for bringing down inflation. And it should be keeping official interest rates on hold, like most economists had expected would happen this week.

But then there was last week’s decision by Fair Work Australia to lift the minimum wage 5.75 per cent – the Government recommended 5.1 per cent, the ACTU wanted 7 per cent, employers wanted 3.8 per cent.

The RBA has constantly said inflation is “stickier” than they thought, staying higher for longer than they expected. And it’s not because of the old argument about the war in Ukraine, because the prices of those affected commodities – wheat, gas, coal – have all dropped significantly.

The RBA says the services sector is behind the high inflation and that sector’s costs are driven by wages.

I’m sure the Treasurer is a good guy, but he has stopped being the economic good guy by constantly promising wage rises and leaving the RBA to play the bad guy role.

But Jim Chalmers and the Federal Budget are the big winners from rising inflation. Wage rises push taxpayers into higher tax brackets, so they pay more income tax.

In fact, average Australians are hit with a double whammy. Sure, they get a pay rise, but the amount of useable cash is reduced by higher tax and what’s left is eaten by high inflation at the shops.

Mortgage repayments as a share of household income will rise to a record high as the large number of ultra-low fixed rate loans continue to roll off over the year. There is plenty of stress to come for many home borrowers over the period ahead.

The silver lining is that interest on savings should also rise for those with spare cash. But the financial institutions always seem to hold some of that back for themselves.

It’s always important to remember that a third of Aussies rent, a third own homes outright and a third are paying off a mortgage. And while those with a mortgage won’t be pleased that rates are rising, it’s a different story for depositors, even with the stingy savings interest rates. This week’s rate hike boosts interest income for households by $3.43 billion over a 12-month period.

Overall, the lift in rates will further dent prospects for retailers and other companies in the consumer discretionary sector, as well as housing-focused areas of the economy such as developers and building material providers. In short, raising interest rates is a very blunt economic instrument.

As you can see this is the fastest, most severe rate cycle in a generation.

So, what are the chances we are heading into an economic recession?

I thought Australia would avoid recession… now I’m not so sure. There is a good chance the RBA rate hikes are just too aggressive and will go overboard.

So there is a better than even chance the Australian economy will follow the rest of the world into recession, which means a lot of financial pain for a lot of people.

Germany, Europe’s largest economy, has officially entered recession due to persistent inflation resulting from Russia’s invasion of Ukraine. The International Monetary Fund data shows growth in Europe’s advanced economies slowing to 0.7 percent this year (down from 3.6 percent last year) and Europe’s emerging economies slowing to 1.1 percent this year (down from 4.4 percent last year).

Meanwhile China, the world’s second-largest economy, is experiencing its own economic turmoil after pursuing a zero-COVID strategy that has crippled growth and sparked social disruption. Zero-COVID and the lack of good-paying, post-graduate jobs have led to the highest level of youth unemployment in China’s history.

What are bond markets saying?

While many investors see the bond market as a bit boring compared to the sharemarket, don’t be fooled. The bond market is an early warning system for economies and markets which are looking a bit shaky.

So, with this fear of economic recession, what are bond markets saying? Remember bond markets simply reflect the cost of money and where that cost will go in the future.

The US bond market is flashing signals of economic trouble, as yields on two-year bonds are now higher than yields on 10-year bonds, in what economists commonly refer to as an “inverted yield curve.” In other words, the bond market indicates that the public expects longer-term economic outlooks to be safer than shorter-term ones. Historically speaking, the inverted yield curve has been a reliable predictor of upcoming recessions.

Here in Australia, Carl Capolingua from ThinkMarkets has posted the following chart showing our short term 2-year Government bonds rising steeply. That means more interest rate rises to come, which is bad for companies, households and the economy.

All this at a time when sharemarkets have been strong. This is why some professional investors are getting nervous. The bond market early warning system is flashing that sharemarkets are overvalued.

“Be fearful when others are greedy… and be greedy when others are fearful”

That’s a great Warren Buffett quote and it’s pretty appropriate right now because sharemarkets are at peak optimism/greed. The following chart tracks investor optimism against the S&P 500 index in the US.

Peak optimism, like now, is historically followed by a big fall in share values.

It’s a time to be careful.

Is the oil price sell rally higher and should you be getting back into oil stocks?

With the global oil price languishing around the $US70 a barrel level, the OPEC oil cartel this week announced production cutbacks to try and boost the price.

What they announced was:

1. Saudi Arabia to extend 500K barrel per day cuts until 2024

2. Saudi Arabia to cut an additional 1 million barrels per day voluntarily

3. Iraq to extend 211K barrels per day cuts until 2024

4. Russia to extend voluntary production cuts until 2024

5. OPEC agrees to new production target of 40.5 million barrels per day

It seems OPEC is not messing around. But can you believe them? Is it time to get back into oil and gas shares?

On my sharemarket show The Call (www.ausbiz.com.au), Gaurav Sodhi from Intelligent Investor and Mathan Somasundaram from Deep Data Analytics were both skeptical.

Gaurav reckons you can never believe anything OPEC says because oil producing countries are just so selfish for the cash. He says they’ll talk tough but then not stick the production cuts because they don’t want to give up the dollars.

Mathan isn’t convinced either. His favourite oil stock is Karoon, but he’s not investing any further money into the sector until there’s proof that production cuts are coming through at a time when demand for oil is falling because of slowing economies.

Great business pivots

My family publishing company produces a newsletter/digital platform called StartUp Daily (www.startupdaily.net) – it’s the bible for the start-up, scaleup, tech sector. I love it because it reports on great young Australian entrepreneurs who are building dynamic businesses.

They come up with an idea and they run with it, but they often have to pivot along the way. Their original idea may not pan out and they have to try something else.

That’s why I love this list of the original products of some of the world’s most powerful brands. It looks like there has been plenty of surprise pivots being made.