Markets, News, Views, Commentaries (Feb 2016)

Equity markets have continued to be very weak, both overseas and locally, as a result of ongoing concerns about global growth, and particularly about China’s prospects.  Australian shares have fared badly year to date, with the S&P/ASX 200 Index down by 10.0%.   The outcome was aggravated by the heavy weighting (47.8%) of the financials in the overall index. Financial stocks have been the weakest sector internationally year to date, and the local financials are down by 14.3%.

Despite this hit to share prices (ie, capital value), it is important for investors not to forget the income flows that can come with a well-diversified share portfolio.  With bank rates at historic lows, dividends remain an attractive income source (see chart below).

Similarly, world shares have been very weak: year to date the MSCI World Index is down by 11.4% in the currencies of its component markets, and by 10.6% in U.S. dollar terms.   The developed economies that have been doing relatively well have fared best, though even in the U.S. and the U.K., share prices have fallen markedly, with the S&P 500 Index down 8.8% and the FTSE 100 down 8.6%. Share markets in the slower growing Eurozone have been weaker again, with France’s CAC Index down 13.8% and Germany’s DAX down 16.5%. In Japan, where the Bank of Japan has had to provide even stronger stimulus to the economy, the Nikkei Index is down 21.4%.

Global share markets have continued to fret about the same set of issues: the outlook for the U.S. economy and its ability to sustain potential increases in interest Global share markets have continued to fret about the same set of issues: the outlook for the U.S. economy and its ability to sustain potential increases in interest rates; the ramifications of possible slower economic growth in China; economic and political problems in some other large emerging economies; the downside risks from sharply lower oil and other commodity prices, and the potential for global deflation; and stresses in the financial sector.

In recent weeks, there has also been an element of self-fulfilling herd behaviour as sellers have been alarmed by calls of a “bear market” and by prognoses of a return of the GFC.

Looking forward, in Australia, the economy is still growing more slowly than usual, though even at this slower rate, it compares well with many other developed economies.  At the moment though, the winding down of major mining projects continues to offset growth in exports and housebuilding.  It may well pick up to a faster rate of growth as 2016 unfolds, though there remain significant risks around export commodity prices.

More positively, the February Westpac/Melbourne Institute Survey of Consumer Sentiment showed that, despite all the bad market news from overseas, households have become a bit happier, and were on balance slightly optimistic and “This is good news in that there have only been five months over the last two years when we have had optimists in the ascendency.”

And globally the U.S. economy, still the world’s largest, seems to be growing at a reasonable rate.  In China, while the economy is certainly likely to slow down, again one can ask whether there has been an overreaction. Chinese statistics are not the best, but on official data the Chinese economy grew by some 6.9% last year, and is expected (according to the Economist’s February poll of international forecasters) to grow by 6.4% this year. A switch from China’s former manufacturing-led boom towards a more services-oriented economy was always inevitable and should not have been “news” to the markets.  Even after some modest slowdown, China’s growth rate remains impressive.

Overall, the global economic environment, while only moderately supportive for corporate profits, is not as poor as the recent equity selloff might suggest, and equity valuations have improved both in absolute and relative terms. But the economics is struggling to get a look in. In what now looks like a good call, the IMF warned in January about “a sudden rise in global risk aversion,” and said “even idiosyncratic shocks in a relatively large emerging market or developing economy could generate broader contagion effects.”

The outlook for global equities in coming months may be more determined by ebbs and flows in investor psychology than anything else.


Sources:  MorningStar research/Economic Update; RBA.  Chart:  RBA/Bloomberg/AMP Capital