Australia’s unemployment rate is at a 48-year low. What’s this mean for ASX 200 shares?

Group of thoughtful business people with eyeglasses reading documents in the office.Group of thoughtful business people with eyeglasses reading documents in the office.

Australia’s economy continues powering home in 2022. The national unemployment rate sunk to a 48-year low last month, while a record number of job vacancies were reported. But is this good news for ASX 200 shares?

These statistics were released in the Australian Bureau of Statistics (ABS) Labour Force summary for June 2022.

The ASX absorbed the news yesterday but investors weren’t so fortunate today. At the time of writing, the benchmark S&P/ASX 200 Index (ASX: XJO) is 0.7% in the red at 6,604 points.

With net employment figures more than 194% above the June forecasts, what does this mean for ASX 200 shares?

Job numbers equal strong economy, market says

More than 438,000 additional Aussies have gained employment this year to date, bringing the participation rate to around 67%.

The jobless rate fell to 3.5%, around 30 basis points off the forecasts of 3.8%. There haven’t been this many Australians in work since 1974.

This creates a systematic dilemma for the Reserve Bank of Australia (RBA), charged with managing inflation and tilting economic growth (GDP) with monetary policy.

One of the functions of the RBA is to keep inflation between 2% and 3%, a mandate it is currently not fulfilling.

The RBA now has to balance the delicate task of tightening near record-high inflation and sustaining a reasonable level of GDP.

However, the latest data indicates a strong economy, which equals high inflation. The market continues to price this in accordingly.

What do the experts say?

Goldman Sachs economist Andrew Boak (quoted by Reuters) said: “With the unemployment rate at a 48-year low, surveyed business conditions well above long-run averages, and COVID-related mobility restrictions fully eased, the economy is bumping-up against capacity constraints in many areas.”

However, as Boak notes, the RBA will struggle to clip inflation without enforcing some form of demand destruction, resulting in a potential recession.

“The Australian economy remains on a path to much higher inflation and interest rates, having entered the tightening cycle with strong momentum,” he said.

Further rate hikes by the RBA are predicted, which could hurt growth and tech ASX 200 shares even further.

The good news is that if inflation cools rapidly, the RBA won’t have to tighten inflation so aggressively. However, inflation data remains strong, and surged to 9.1% in the United States in June.

Plus, high employment puts pressure on the labour market and increases wage growth, thereby increasing purchasing power and deposits.

What about ASX 200 shares?

It then becomes a question of what ASX 200 shares will do well in what situation. If we enter a recession, for instance, defensive shares are seen as the most sensible play.

In a recent update, PIMCO bond portfolio manager John Waltwies said it’s going to “be a year when investors pivot from worrying about inflation to worrying about recessions”.

“Investors … should be thinking about how they can build some more resilience into their portfolios,” he said. “So, thinking about going up in quality, up in liquidity.”

This sentiment was echoed by analysts at HB Insights in a recent note. They said that “[p]rofitability and cash flow metrics [are] quality factors investors are now paying a premium for”.

Meanwhile, Goldman Sachs equity strategist David Kostin said: “Roughly a third of investors’ portfolios should focus on companies with a ‘margin of safety’, meaning they would still be attractively valued even if their earnings fell by 20%.”

This “should be coupled with high-dividend stocks, which are arguably the most dislocated part of the market today,” he added.

Diversification is also something to consider. Usually, there’s a diversification benefit between stocks and bonds. However, as researchers at JP Morgan recently found, that relationship breaks down in times of high inflation.

As such, both stocks and bonds have suffered their worst pain on record this year, and the traditional “60/40” portfolio (60% allocated to stocks, 40% to bonds or bond ETFs) has incurred some of its worst losses ever, the broker said.

The relationship is shown on the chart below, using the US market instead of the ASX 200. When inflation began to tick up, shares and bonds began to fall.

TradingView Chart

Hence, if an economy is heading towards a recession, experts suggest focusing on companies that sit within the ‘quality’ pocket of the market.

If inflation remains between 3% and 5%, this could force the RBA to tighten even further, reinforcing the cycle.

Time will tell where we head next.

The post Australia’s unemployment rate is at a 48-year low. What’s this mean for ASX 200 shares? appeared first on The Motley Fool Australia.

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Motley Fool contributor Zach Bristow has no position in any of the stocks mentioned. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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