Markets

Downside risks creeping into the ASX

Mon 24 Jan 22, 2:53pm (AEST)
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Key Points

  • Will higher interest rates level the market or drive a full blown bear market?
  • Covid winners struggle to cycle elevated sales
  • Supply chain headwinds and staffing shortages squeeze company margins

What started out as a rotation away from tech into cyclicals has turned into sell everything.

In the new year, the ASX 200 is down -5.8% to an 8-month low. 

From a technical standpoint, the index has dipped below its 200-day moving average for the first time since October 2020. Painting an increasingly bearish picture, where the index needs to bounce back quickly to stay out of trouble. 

XJO 2022-01-24 13-39-17

ASX 200 daily chart, TradingView

Regardless of what might happen in the coming days, slicing through the 200-day flags a weakening trend. 

After a record setting 2021, the risk/reward doesn't quite feel right in 2022. Here are some key downside risks to consider.

Interest rates to rise, but how fast? 

Equity markets have pulled back sharply in an attempt to price-in the new playing field of higher interest rates. 

In the US, a majority of the Federal Open Market Committee (FOMC) members see at least three interest rate hikes this year, with the first 25 basis point hike to kick off in March.

This view has also been reflected in the  US 2-year Treasury yield, which reflects short-term interest rate expectations. The 2-year has risen four-fold since September 2020, topping 1% for the first time in two years.

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US 2-year Treasury yield vs. US interest rate, TradingView

Closer to home, economists have also begun bringing forward their interest rate expectations. 

Last Thursday, Westpac said it expects the RBA to begin raising interest rates in August this year.

Likewise, Shane Oliver, chief economist at AMP sees a potential 15 basis point hike in August.

Richly valued tech stocks copped the brunt of the selling. Now, this contagion has spread to the rest of the market amid concerns that raising rates too quickly could damage the real economy.

The US Federal Reserve will kick off its first interest rate meeting for the year on Thursday.

Rate hikes put property markets at risk

Earlier than expected interest rate hikes could put the all-important Australian property market at risk.

In CoreLogic's December 2021 market update, it flagged:

"... housing markets are likely to be sensitive to any increase in the cost of debt. Similarly, a further tightening in housing credit policies would also act as a dampener on housing activity."

Earnings season: a covid hangover 

US earnings season and local quarterly reports have flagged a recurring theme of elevated costs and earnings volatility. 

Netflix, for example, plunged -21.8% after the December quarter flagged slowing subscriber growth and the slowest revenue growth since 2012.

More and more covid winners are turning into vaccine losers, struggling to deliver on growth after the pull-forward effect of covid.

Local names like Redbubble (ASX: RBL) and Kogan.com (ASX: KGN) are already fast approaching pre-covid levels, down more than -50% from 2021 highs.

Where did my margins go?

Supply chain and staffing challenges is another dominant theme keeping company earnings at bay.

The elevated cost environment has driven sharp one day declines across stocks of all sectors.

A defensive blue-chip stock like Woolworths (ASX: WOW) fell -7.7% on 14 December after flagging "ongoing material costs of operating in a covid environment".

Other notable stocks that have staged sharp one-day, announcement driven declines include Adairs (ASX: ADH), Inghams (ASX: ING) and South 32 (ASX: S32).

Written By

Kerry Sun

Finance Writer & Social Media

Kerry holds a Bachelor of Commerce from Monash University. He is an avid swing trader, focused on technical set ups and breakouts. Outside of writing and trading, Kerry is a big UFC fan, loves poker and training Muay Thai. Connect via LinkedIn or email.

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