From the desk of the CIO: Are we seeing market recovery?

By Bryce Anderson, Senior Portfolio Manager

• We’ve seen a market rebound after March sell-off
• These events are not a repeat of 2022 or 1970s high inflation.

Markets have staged a rebound after the March sell-off, rewarding investors that stayed invested or topped up portfolios. The sell-off was not large enough to unearth many bargains but it did reduce speculation and injected better value as investors became more cautious. We selectively added exposure in the sell off. Morningstar portfolios continue to blend broad diversification, specific investments to mitigate more extreme scenarios and attractively priced granular opportunities like Healthcare, Consumer defensive and regions like Brazilian equities.

The big question now is whether the stand-off between the US, Israel and Iran will create a lasting and large rise in inflation and trigger economic slowdown.

In the short term, expect higher inflation. Higher oil and gas prices are clearly flowing through to higher goods prices. The longer the hit to Middle East energy production and export, the bigger the inflation impact. Governments are already stepping in to support consumers with subsidies but not to the extent seen back in 2022.

This is not a replay of the 2022 embargo on Russian exports or the start of a 1970s style stagflation. The energy supply shock from the Middle East this time is far less impactful. That’s because the world’s energy supply is way more diverse than before and rapidly increasing. The old saying that “the cure for high oil prices is high oil prices” is borne out by the hunt for alternatives that have lessened oil and gas demand and put downward pressure on prices.

The first is more efficient use of energy across economies, that started back in the 1970s and 1980s. That was followed by the search for newer oil and gas supplies culminating in shale oil, oil sands, and deep sea oil fields including those here in Australia. Our colleagues at Morningstar Equity Research and Morningstar Multi Asset Research point out that gas supplies are surging, much of it from Canada and the US. By end 2027, new natural gas supply is expected to be twice the 2024 gas output from Qatar.

Equally important is the development of solar and wind power generation and electric transport. These strategic alternatives to oil and gas can be scaled much more quickly and cheaply, so at the margin they too are sapping demand for oil and gas.

All these factors mean the probability is low of a large, sustained rise in energy costs from current levels. On top of that, the pass through of higher energy costs to prices of goods and services is muted, by rising unemployment and the impact of AI. Labour markets have far more slack in them now than back in 2022 and the Union dominated wage setting of the 1970s. So, we do not see lasting large economic slowdown or increases in interest rates as likely, especially with interest rates above inflation rates, unlike 2022 and the 1970s.

The big takeaway is that staying invested and remaining well diversified is the most reliable way to manage risk, profit from uncertainty and help investors reach their goals.

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