ASX 200: is a correction coming?

The ASX 200 is widely regarded as the benchmark for the Australian economy, akin to the UK’s FTSE 100, or the US’s S&P 500.

However, the global interconnectedness of the best ASX 200 stocks, combined with the lack of diversification in the index, means that price fluctuations can usually be attributed to external factors rather than domestic problems, especially during global downturns.

For context, financial services stocks make up 28.3%, materials stocks, 17.9%, and healthcare stocks, 10% of its overall weighting. These three sectors are inarguably disproportionately impacted by global market movements.

Every other sector combined, most of which are domestically focussed, comprise less than half of the ASX 200’s overall performance.

However, healthcare is disproportionately represented by biotech researcher CSL Limited, which comprises 6.44% of the overall weighting. And the company has remained essentially flat over the past year by dint of its defensive qualities.

This leaves just financials and materials as the key index movers.

ASX 200 currency challenges

Domestically, inflation-fighting interest rate rises are benefitting Australia’s largest banks — Commonwealth, Westpac, National Australian, ANZ, and Macquarie — and will continue to up to a point.

Rising net interest margins are going up, with Australia's Reserve Bank once again increasing the cash rate by 25 basis points to 2.6%. In the face of 6.1% CPI inflation, Governor Philip Lowe has warned that the bank’s aim to return inflation to within the range of 2% to 3% means that ‘further increased are likely to be required over the period ahead.’

However, rising rates alongside supply-side inflation could do serious domestic economic damage.

One key indicator is the rapid cooling of the raging housing market. With new loans fast becoming unaffordable, a Digital Finance Analytics model shows that in a worst-case scenario, house prices could fall by 44.3% from their peak by the end of 2025.

Of course, Australia isn’t alone in grappling with this problem, with the UK, US, and EU all facing the same issue. Internationally, monetary policy is tightening. But this represents a problem for ASX 200 financial services stocks.

For example, the outsized strength of the US dollar, a potential symptom of a global liquidity crisis, may help Australian commodity sellers, but is making imports more expensive as many importers buy their wares priced in US currency.

Likewise, the September sterling crash, a result of diverging monetary and fiscal policy in the UK, hit the ASX 200 hard as worries of a global financial crisis cascaded through the markets. Any repeat of 2008 or similar could see the recovering bank stocks fall fast.

ASX 200: China slowdown and OPEC+

Materials stocks, including titans BHP Group, Rio Tinto, and Fortescue, constitute the second most important sector in the ASX 200. But as cyclical stocks, they also risk share price falls amid a global recession.

Of course, commodity prices are notoriously difficult to predict. For example, OPEC+ is scaling back daily oil production by 2 million barrels a day, which will help keep prices elevated. And most of the major commodity metals, including iron, aluminium, copper, and gold remain at historically high levels, despite coming down in recent months.

Certainly, it’s this which is giving the Australian dollar relative strength against most other currencies. But again, it also represents a two-fold risk, as falling commodity prices will hit both the ASX 200, and the currency it is traded in.

And beside the clear risk of widespread demand destruction, one specific sword of Damocles looming over the index hangs from China. By far Australia’s largest two-way trading partner, China has accounted for between 31% and 36% of trade over the past few years.

A collapse of China’s housing market, which in 2021 accounted for circa 25% of its GDP, may be on the cards. In addition, Taiwan tensions, environmentally-induced power shortages, and an interminable cycle of pandemic lockdowns are all contributing to an agonising slowdown.

The ASX 200 may not be far behind.

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