Stock Market Could Fall as Low as 7,200 Points

Not surprisingly, the RBA raised the official interest rate again last week by another 0.25 per cent in an attempt to curb inflation making this the ninth consecutive rise. While we have seen interest rates at this level before, it has been quite some time. But the good news is that around half the time that the rates have been rising, the Australian stock market has risen well over 10 per cent. So, to what degree does inflation impact the stock market.

The impact of inflation on the stock market

We know inflation effects interest rates as the RBA continues to use this tool to either stimulate or slow the economy. But inflation also impacts the stock market in a positive way, as a moderate level of inflation can be a sign of a growing economy, increased consumer spending, and rising corporate profits.

However, as we have experienced in the past year, if inflation exceeds the RBA's preferred target it can lead to increased interest rates to slow economic growth. But here is the twist, while we want growth, as this leads to greater profits and, in turn, rising stock prices, continually increasing interest rates can do the opposite. If profits drop, dividends may fall, therefore, if the RBA continues to raise interest rates, investors may move out of the stock market into other assets, such as cash, to gain a better income yield.

In an inflationary economy, some stocks will be more effected by rate rises while other companies will benefit. Industries such as energy, materials, and consumer goods can be more susceptible to changes in interest rates especially rising interest rates. Banks, on the other hand, tend to benefit, as they are slow to pass on the savings when interest rates fall but very quick to pass on rate rises, therefore, creating more profit for themselves.

The good news is that I believe we are nearing the end of rising inflation and rate rises, with it likely to end in the next few months.

What were the best and worst performing sectors last week?

The best performing sectors included Financials down 0.35 per cent, followed by Energy down 0.51 per cent and Materials down 0.76 per cent. The worst performing sectors included Information Technology down 4.20 per cent followed by Health Care down 3.63 per cent and Utilities down 3.08 per cent.

The best performing stocks in the ASX top 100 included Newcrest Mining up 10.24 per cent followed by Medibank Private up 5.78 per cent and Suncorp up 3.97 per cent. The worst performing stocks included Wisetech Global down 12.19 per cent followed by Block down 10.62 per cent and ARB Corporation down 10.33 per cent.

What's next for the Australian stock market?

The All Ordinaries Index closed lower last week, trading down in price below the lows of the prior two weeks to close at 7,631 points. As I have said in previous reports, the Australian market has been very bullish this year, so the likelihood of it falling was quite high.

If the market has made a peak which I suspect it has, it may fall a further two percent to around 7,500 points or below. If the fall is short in both time and price, then it’s likely the market will turn to rise sharply and push through the previous all-time high to the next high sometime in March.

That said, I am mindful that the fall may be more sustained, which means we could see a fall over several weeks to between 7,500 points and 7,200 points. If this occurs, there will be many great buying opportunities in our market. Either way, now is not the time to be complacent, instead you should be preparing to set up your portfolio for the rest of the year.

In the short term, I expect the Consumer Discretionary and Materials sectors to ease off and the Financial sector to be flat but there is likely to be some great opportunities in Energy and Information Technology.

For now good luck and good trading.

Dale Gillham is Chief Analyst at Wealth Within and international bestselling author of How to Beat the Managed Funds by 20%. He is also author of the bestselling and award winning book Accelerate Your Wealth—It’s Your Money, Your Choice, which is available in all good book stores and online.