Markets, News, Views, Commentaries (July 2017)

Markets, News, Views, Commentaries…..

Two trends are setting the agenda for asset prices. One is the ongoing global economic expansion: Recent data suggest the outlook has improved a bit further, and equities are likely to continue to benefit. The other, however, is the prospect of less supportive monetary policy: Major central banks (ex Japan) will not be providing the same degree of stimulus as previously, and this will continue to weigh on bonds and bond-like assets such as property and put a spotlight on equity valuations. The central banks will have the biggest effect on the assets most in favour during the previous “hunt for yield” period. In Australia, the economic outlook remains middling rather than strong, as household caution continues to battle with business optimism.

Gains for Australian shares have been remarkably modest in a year that has been friendly to most other equity markets. The S&P/ASX 200 Index is up only 1.6% in capital value and up 3.8% in total return. Certainly a fair part of the answer is the poor performance of the financial sector which, with such a large weighting of the index, has an unavoidably big impact.  For the year to date financials are down 0.5% in capital value.

Looking ahead, the Australian economy continues to grow but at a slower pace than ideal. Previously, the slower than usual growth was down to the non-mining economy not growing quite quickly enough to pick up the slack left after the end of the resources investment boom but more recently the slowish growth has been down to the cautious household sector offsetting more-optimistic spending plans in the business sector.

Consumers have held general concerns for quite some time, unlike business which is much more upbeat.  The most recent Roy Morgan Consumer survey (taken in May, published this month) showed that “Economic issues were mentioned by more Australians than the next three sets of issues combined,” with unemployment, the general state of the economy, and housing affordability all high on their radar.

After a period in June and early July when equity markets had weakened on fears of less-supportive monetary policy from a number of central banks, more recently global shares have picked up again as investors have taken a more sanguine view of the likely speed and scale of the central bank moves. It has also helped that the Chinese economy logged faster than expected economic growth in the June quarter.

As reported in last month’s Newsletter, the world outlook is good, and is indeed strengthening.  While the most recentinflation and retail sales data in the US was weaker than expected, this is thought to be an aberration set against a generally stronger US and world economy. There is certainly little sign of the US economy faltering. The very latest reading (the IHS Market US Business Outlook survey for June, published on July 16), supports this: “The net balance of firms reporting confidence towards future business activity rose from +27% in February to +35% in June. This is the highest reading since June 2014, with firms citing that sentiment was influenced by opportunities for expansion.”

 

The global version of the survey found an equally positive outlook for the world economy: “Global business optimism is running at a three-year high with an improved outlook for corporate profits, employment, and investment intentions underscoring the increasing robustness of the economic upturn.”

But with all that said, markets still face risks and uncertainties.   Prime example, a strengthening global economy means that the interest rate rises that investors appear to fear so much or more likely to materialise. However investors have become very casual about potential risks as the VIX Volatility chart below shows.    As Merrill Lynch said in a recent letter, “a fearless market is one usually feared by seasoned investors”.

The VIX chart shows that volatility (or ‘investor fear/uncertainty’) is at its lowest point since before the GFC.

The Aussie Dollar:    The Australian dollar has strengthened, particularly in the last week or so after congressional testimony by the chair of the Federal Reserve, Janet Yellen. The US dollar fell globally as a result, and the Australian dollar rose as a collateral beneficiary, with the AUD now up 8.0% for the year to date against the USD, at USD 0.7970 at time of writing. The AUD is also up, but by smaller amounts, against most other currencies (except the Euro, where it is slightly down), and on an overall trade-weighted basis the AUD is 3.9% higher since the start of the year.

Currency forecasting, as ever, is problematic, particularly (as we have seen in the past few weeks) when hard-to-forecast global influences, like the outlook for the US dollar, get superimposed on local developments. As we’ve said in prior months’ Newsletters, a quick check around the place reveals a very wide range of forecasts ranging from a slump in the AUD during the next year to USD 0.60 to further appreciation towards USD 0.80. The average view, however, was for a gradually lower AUD during the next year, from USD 0.79 now to USD 0.717 by the middle of next year.  And if the US Fed were to stick to its plans of gradually raising US interest rates and the RBA sticks to its plans of leaving local rates alone, then a lower AUD looks a plausible outcome. 

Sources:  Morningstar Research; CBOE.com;  CBA Research & ComSec; RBA.