Market Watch: Why shares are falling again

The stock market recovery faltered this week as the US Federal Reserve chair Jerome Powell made it clear that the inflation fight still has a long way to go.

Investors should expect more pain before the end of the year as higher interest rates start to hurt corporate earnings, says Pie Funds chief executive Mike Taylor.

Looking at the scale of the challenge ahead of central banks, markets probably shouldn't have been surprised by the tone of Powell's message, he said.

But they were.

"I think the market was expecting him to say that, we think inflation has peaked and, if it has peaked, we expect interest rate rises to be coming to an end," Taylor said.

"Whereas, he actually said the opposite to that. All his rhetoric was very strong, very hawkish."

Powell made it clear that the Fed was prepared to see a much weaker economy to be sure that inflation was really coming down.

"He was trying to talk the markets down. If you think about we have inflation [in the US] running between 8 and 10 per cent, interest rates hiked up quickly, but we had an S&P 5000 that was only a couple of hundred points off an all-time high," Taylor said.

It just didn't feel right. So I think he said the right thing."

A quick return to a bull market and a straight line recovery off of June's lows was always a bit optimistic, Taylor said.

That had been some good signs on global inflation and that had buoyed markets, but there was still plenty of risk and volatility, he said.

There was now talk of OPEC cutting oil production and pushing prices up, there were more food supply issues emerging with drought in China and other climate change events around the world.

Getting inflation back under two per cent was going to be quite a challenge and might require central banks to keep their target rates higher for longer, Taylor said.

"That could be quite painful."

Mike Taylor, founder and chief executive of Pie Funds. Photo / Supplied

"You would expect that markets would continue to sell off into the year-end," he said.

The only reason they weren't significantly lower already was that consumer sentiment was still holding up well.

Fixed mortgage rates meant the impact of higher rates took time to hit consumers in the pocket, especially in the US where terms of 10, 20 and 30 years were common.

So will we see the market hit new lows in the months ahead?

It's possible, Taylor said.

It was going to be very hard for the market to "hold up against the weight of economic data coming against it" the next few months, he said.

"Economies and earnings are probably going to continue to slow down. Yes, it has held up but as we talked about there is a lag effect. You'll start to see that coming through in earnings and that's not going to be good for stocks."

Given how committed Powell and the Fed now seemed to higher rates, the market would probably need to head lower before central banks could be convinced to ease off, Taylor said.

"I think this will be a point for investors to be very cautious for the next couple of months."

- The Market Watch video show is produced in association with Pie Funds.