Global equity markets have continued their recovery from the sell-off after the United Kingdom’s Brexit vote. Australian equities shared in the initial global post-Brexit recovery, but have essentially gone sideways more recently with the S&P/ASX 200 Index little changed from its end of July level.
In Australia, the long period of slower-than-usual economic growth shows little immediate sign of accelerating into a stronger recovery that would make a sizeable difference to the outlook for corporate profitability. The RBA’s latest assessment (in its 5 August Monetary Policy Statement) is the long-awaited emergence from the post-mining-boom slowdown is still over the horizon: a pickup to faster growth (in the 3% to 4% range) still looks some distance away (the RBA has it in 2018).
The recent performance of world equities, with the U.S. the pick of the developed economies and strong price rises in some of the emerging markets, aligns strongly with the most recent assessments of the global economic outlook.
The International Monetary Fund, or IMF, in the latest (July) update of its World Economic Outlook, expects the world economy will grow by 3.1% this year and pick up a little to 3.4% growth next year. However, the pattern is uneven with the developed economies expected to grow by only 1.8%, with the U.S. doing better (2.2% growth this year) than either the eErozone (1.6%) or Japan (0.3%), while the emerging economies are expected to grow quite strongly (4.1% this year, 4.6% next).
Another way to see the currently high level of expectations is in the pricing of the VIX index, (chart below) which measures the volatility investors expect to encounter from holding the S&P500 index and which is now at very low levels. It had spiked in January and February (on fears of a slowdown in global business activity), dropped back in subsequent months, jumped again in June (Brexit), and once more dropped back in recent weeks, to its lowest levels of the year. Investors are currently over-relaxed about the risks to the global economy. They are not completely complacent—shares which fail to meet expectations are getting hammered—but an additional element feeding into unusually high valuations is an underappreciation of the potential for adverse surprises.
Sources: Morningstar research/Economic Update July 2016; RBA, Bloomberg, Yahoo7 Finance (Chart).