Interest rates and inflation are close to their peak
When everyone is talking rates and inflation, I’m looking forward to what comes next. The newspaper headlines are dominated by rising prices and the associated interest rate hikes which are coming. I don’t doubt this.
But history and experience has taught me that most of the current news is already in the price and to be a successful investor, you need to look through the valley and focus on what comes next.
It’s not about today, or tomorrow. Its about the next 12-24 months.
Last month I wrote a note about the price of oil and cautioned that oil has a self correcting mechanism. Everytime it goes up, it breaks the global economy and global growth. This in turn reduces demand and oil eventually comes back down. I don’t have a crystal ball when writing these notes. But since I published these views, oil has fallen around 20%. Admittedly from elevated levels.
Here’s how I think inflation, interest rates, stocks and house prices move next.
I truely believe that we have seen a peak in inflation. A lot of this recent inflation is base effect. We’re rising from pandemic levels where the cost of housing and energy collapsed. We’re also coming out of the pandemic which structurally changed the entire labour force. The unemployment rate is down because many workers have left the labour force.
The male participation rate in Australia hasn’t changed for the past 10 years. They stopped looking for work.
But many of these factors are now starting to change. Rising interest rates are dampening demand and this will help address supply chain issues. Chinese factories won’t stay closed or disrupted forever. The war in the Europe won’t last forever. Nothing lasts forever.
Oil prices are rejecting higher levels. Commodities are also diving, copper for example is down significantly.
Inflationary numbers are also impacted by rising housing costs. For example, the US inflationary numbers which seem scary at 9% have rental assumptions which might be impacted by an adjustment post covid when rents actually came down. House prices in major developed economies are coming off the top, this will help cushion speculative inflationary drivers.
So in the next few months we’ll start to see scary inflation numbers here in Australia too. The Reserve Bank of Australia will need to follow the US, UK and Canada in bringing the cash rate back to 2-2.5%. Things will slowdown. But then sometime early next week, when growth starts to look weak and supply issues are addressed, we might be back to talking about lower rates again.
A cash rate of 2-3% to me seems like a natural rate given our demographics and economic growth prospects. Rates are 0-1% are fake and temporary. We’re now seeing the consequences.
Stocks and real estate yielding 4-6% are healthy market levels. We’re not that far away, so I’m less scared and somewhat feeling more comfortable about the medium to long term. Expect more rate rises in the next few months, followed by a shake out before income, rents and yields adjust. Then we’ll be back to normal levels which will form a base for the next upward cycle.
Now is the time to be brave.
I've seen gluts not followed by shortages, but I've never seen a shortage not followed by a glut - Nassim Taleb
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