Global equities have bounced back in the second half of 2022 following a challenging start to the year. The MSCI World Ex Australia Index (in AUD) delivered a total return of -8.4 per cent for the year to mid-August and has bounced more than 10 per cent from its lows. The ASX 300 Index has seen a similar rally over that period. While inflation remained elevated and central banks across the globe continued to raise interest rates, optimism increased that there will be a slowdown in this tightening cycle and recent corporate earnings have been better than expected.

Headline inflation in the US eased slightly in July to an annualised rate of 8.5 per cent, although core inflation remains well above the long-term target. The Federal Reserve maintained a hawkish stance and raised interest rates by 75 basis points (bps) again in July. In Australia, inflation has become more broad-based and hit 6.1 per cent in June. The Reserve Bank of Australia (RBA) increased the cash rate by 50bps in August for the third consecutive month and signalled that it expects inflation to remain high over the near-term. The 10 year Australian government bond yield briefly pushed above 4 per cent earlier in the year, although has pulled back in recent months as growth concerns emerge.

Source: Factset on 16/08/22

There are signs that we may be getting closer to “peak inflation” signalled by the improvement in global shipping rates, easing semiconductor pressures and a pullback in commodity prices. While the US unemployment rate remains very low, we expect this to rise as some companies (particularly in the information technology sector) have started to implement hiring freezes or are reducing headcount. Despite these positive signs, inflation uncertainty remains high given the conflict in Ukraine, a tight US labour market and China’s covid-zero policy.

Global Purchasing Manager Indices (PMIs) have been mixed with higher European energy prices and Chinese lockdowns having a negative impact. China also appears to have backed away from its 5.5% GDP growth target for 2022. While we expect a weakening economic environment, we see a stagflation scenario as unlikely given we expect inflationary pressures to ease towards the end of the year. However, recession risks have increased and central banks face a difficult balancing act.

Corporate earnings are forecast to grow strongly this year and the recent US earnings season was ahead of expectations. Excess savings from the pandemic also mean consumers are reasonably positioned to deal with higher interest rates in the near-term. Moving forward we expect to see more earnings headwinds and believe that current estimates will likely need to be reduced further due to higher input costs, lower demand and company margins above longer-term averages.

Earnings estimates for ASX 300 Index

Source: Factset consensus forecasts on 16/08/22

We expect equity market volatility to remain high in 2022 and are cautious given the strong rally in recent months. Despite some positive signs, the inflation outlook remains uncertain, central banks have maintained a hawkish stance and we expect corporate earnings will weaken moving forward.