Trying to time investment markets is difficult if not impossible at the best of times, let alone now. The war in Ukraine, coupled with rising inflation and interest rates, have all added to market uncertainty and volatility.

At times like these, investors may be tempted to retreat to the ‘safety’ of cash, but that may be costly. Not only is it difficult to time your exit, but you may miss out on any upswing that follows a dip.

Take Australian shares. Despite COVID and the recent wall of worries on global markets, Aussie shares soared 64 percent in the two years from the pandemic low in March 2020 to the end of March 2022.i Who would have thought?

So, what lies ahead for shares? The recent Federal Budget may contain some clues.

The economic outlook:

The Budget doesn’t only outline the government’s spending priorities, it provides a snapshot of where Treasury thinks the Australian economy is headed. While forecasts can be wide off the mark, they can influence market behaviour.

As you can see in the table below, Australia’s economic growth is expected to peak at 4.25 percent this financial year, underpinned by strong company profits, employment growth and surging commodity prices. Our economy is growing at a faster rate than the global average of 3.75 percent, and ahead of the US and Europe, which helps explain why Australian shares have performed so strongly.ii

However, growth is expected to taper off to 2.5 percent by 2023-24, as key commodity prices fall from their current giddy heights by the end of September this year, turning this year’s 11 percent rise in our terms of trade to a 21 percent fall in 2022-23.

Table: Australian economy (% change on previous year)

Actual %Forecasts %
Gross domestic product (GDP)
Consumer prices index (CPI)
Wage price index1.72.753.253.25
Terms of trade*10.411-21.25-8.75

*Key commodity prices assumed to decline from current high levels by end of September quarter 2022
Source: Treasury

Commodity prices have jumped on the back of supply chain disruptions during the pandemic and the war in Ukraine. While much depends on the situation in Ukraine, Treasury estimates that prices for iron ore, oil and coal will all drop sharply later this year.

So, what does all this mean for shares?

Share market winners and losers:

Rising commodity prices have been a boon for Australia’s resources sector and demand should continue while interest rates remain low and global economies recover from their pandemic lows.

Government spending commitments in the recent Budget will also put extra cash in the pockets of households and the market sectors that depend on them. This is good news for companies in the retail sector, from supermarkets to specialty stores selling discretionary items.

Elsewhere, building supplies, construction and property development companies should benefit from the pipeline of big infrastructure projects combined with support for first home buyers and a strong property market.

Increased Budget spending on defence, and a major investment to improve regional telecommunications, should also flow through to listed companies that supply those sectors, as well as the big telcos and internet providers.

However, while Budget spending is a market driver in the short-to-medium term, there are other influences on the horizon for investors to be aware of.

Rising inflation and interest rates:

With inflation on the rise in Australia and the rest of the world, central banks are beginning to lift interest rates from their historic lows. Australia’s Reserve Bank has recently raised the official cash rate after more than 11 years of no increases.

Global bond markets are already anticipating higher rates, with yields on Australian and US 10-year government bonds jumping to 2.98 percent and 2.67 percent respectively. However, the yield on some US shorter-term bonds temporarily rose above 2.7 percent recently. Historically, this so-called ‘inverse yield curve’ has indicated recession at worst, or an economic slowdown.iii

Rising inflation and interest rates can slow economic growth and put a dampener on shares. At the same time, higher interest rates are a cause for celebration for retirees and anyone who depends on income from fixed interest securities and bank deposits. But it’s not that black and white.

While rising interest rates and volatile markets generally constrain returns from shares, some sectors still tend to outperform the market. This includes the banks, because they can charge borrowers more, suppliers and retailers of staples such as food and drink, and healthcare among others.

Putting it all together:

In uncertain times when markets are volatile, it is natural for investors to be a little nervous. But history shows there are investment winners and losers at every point in the economic cycle. At times like these, the best strategy is to have a well-diversified portfolio with a focus on quality.

For share investors, this means quality businesses with stable demand for their goods or services and those able to pass on increased costs to customers.

If you would like to discuss your overall investment strategy, please do not hesitate to get in touch with our team of Senior Financial Advisers.