Share market rally on thin ground, as economic storm clouds gather

A toxic cocktail of soaring inflation, interest rates, energy and mortgage bills has failed to shake faith in the share market.

The S&P/ASX 200 is down just 6 per cent over the last month and jumped 1.8 per cent on Tuesday despite the world facing the largest energy supply shortages since 1973.

The share market has barely moved even as local service stations run out of fuel, petrol bills surge, diesel costs rocket 80 per cent, and economists warn inflation will soon reach 5.5 per cent at the same time as interest rates jump.

Share market investors ignore stagflation risks

But bond, commodity and Australian dollar traders have all hit the sell button in servitude to the prospect of a major downturn linked to the destructive consequences of high inflation over the rest of 2026.

“A torrid month for the dollar and Australian bond market, the former under the all-consuming influence of the Iran war which commenced right on the eve of March,” said NAB on Wednesday. “The subsequent surge in oil prices, resulting from Iran’s blockade of the Straits of Hormuz, brought stagflation fears sharply to the fore.”

But share market investors aren’t worried about a stagflation cocktail of feeble growth, rising joblessness, and falling asset prices.

They either disagree with bond traders that inflation and interest rates are almost certain to jump, or feel the extreme uncertainty about the Middle East war’s future, when waged by an erratic US President Trump, justifies their greater optimism.

For sure, share buyers pushing Wall Street and the S&P/ASX 200 higher on Wednesday are also discounting the chances of a land invasion of Iran to virtually zero.

Instead, they’re betting on rapid peace-deal headlines as President Trump ends the war.

“Trump’s final calculation appears relatively straightforward,” Betashares economist David Bassanese said of the market’s thinking.

“US boots on the ground, or significant damage to civilian energy infrastructure, would likely push oil prices to US$200, trigger a US recession, and potentially lead to Democratic control of Congress and impeachment proceedings against Trump.”

Mistaken short-term focus

Perhaps though share investors are too focused on the day-to-day headlines in making their decisions to buy or sell. And losing sight of the gathering economic downturn linked to higher rates and inflation over the next 12 months.

Whereas bond market investors are much more focused on what will happen to inflation and interest rates over six months, to one year, five years, 10 years or longer.

The bond market then is spelling out a medium term downturn and the share market is, perhaps, yet to catch up in moving lower.

This is a similar scenario to the early stages of COVID-19 in January and February 2020.

As the virus spread across the world investors continued to push share markets higher right up until February 20, 2020. This was because they were sufficiently uncertain about their knowledge of the day-to-day future to doubt that the coronavirus would turn into the worst global pandemic since the Spanish Flu of 1918.

But after the penny dropped that the coronavirus would prove at least a year-long event the S&P/ASX 200 crashed 35 per cent. between February 20, 2020 and March 23, 2020.

So far shares have largely moved in line with new daily knowledge about the war’s progress as a reflection of the market’s short-term focus. But if the market eventually moves on to focus on the consequences of the energy shock and associated inflation it could yet repeat a COVID-style crash.