The global economic outlook has continued to improve, and both the forecasting and investing communities now expect stronger economic activity (benefiting growth assets) but also higher inflation (adversely affecting bonds and other income-oriented asset classes). Uncertainty has risen, partly because of lack of clarity around Trump policies and partly because of various geopolitical and financial risks, and it is a concern that current asset valuations appear to be underestimating the potential for unpleasant surprises.
Here in Australia there have been mixed signals, but the long-awaited acceleration in business activity is still elusive—although the miners have been doing very well as some prices have soared, the rest of the economy still looks to be facing a further period of slower-than-normal growth. It is still not clear whether the economy will pick up from its post-resource-boom slowdown. The RBA thinks it will, saying in its latest Monetary Policy Statement that it thinks the economy is currently growing slowly, at a 1.5% to 2.5% annual rate, but that it will pick up later this year. The bank said, “GDP growth is expected to pick up over 2017 to 2½–3½ per cent, supported by low interest rates, the diminishing drag on growth from falling resource investment and rising resource exports,” which would be better, though far from a new boom-time.
Globally, shares have been driven by two main considerations: (i) investors’ attempts to discern the likely policies of the Trump administration, and importantly (ii) generally improving data on global economic prospects.
Initially, global equities responded very positively to the Trump administration, based on an expected fiscal boost to the U.S. economy, but had second thoughts in January on concerns about damage to world trade from potential U.S. protectionism. More recently again, sentiment has become more positive, principally on expectations of a (still-unspecified) tax package that may be good for U.S. corporate profitability.
And so it follows that these two dominant and somewhat conflicting themes will continue to be the main impactors affecting the outlook for global markets. The evidence of stronger global economic activity is already reflected in the latest global business surveys (ref JP Morgan Global All-Industry Index which covers both manufacturing and services) but this is to some degree countered by the rising levels of risk and uncertainty – the World Bank, while noting the expectation of better growth in 2017-2019, also made mention of the downside risks “of prolonged periods of heightened policy uncertainty following recent election results in key economies, mounting protectionist policies, and the potential for disruption caused by sharp changes in interest rate levels or exchange rate movements”.
Sentiment will play a key role in all of this – Perhaps the optimists will be proved right and growing momentum for the world economy will carry the day, and none of the economic, political or financial risks will prove material enough to derail the underlying support for improved corporate profitability.
The final quarter of 2016 will mostly be remembered as Trump being voted in as the President of the United States of America, and the months before and after this major political event have been volatile. As seen in the table below it was a tough start to the December quarter with many markets falling and some with their biggest declines in years. This however was largely reversed or reduced in November and December for most sectors, and continued on the up in general through January and into February.
Sources: Morningstar research; CBA Research; RBA, Bloomberg,YieldReport, Knoema.