Markets, News, Views, Commentaries (March 2017)

Both growth and inflation have been picking up globally. Higher economic growth has been, and will continue to be, helpful for equities but rising inflation will also be challenging for bonds and other income-oriented asset classes. Asset valuations (share prices) generally remain expensive, and are vulnerable to any unexpected adverse shocks especially as investors appear to be factoring in low levels of concern about the probability of political or other surprises.   The Trump rally has rolled on, though may seem to be losing a little steam.

Here in Australia, there is still no clear evidence of a pick-up in economic growth. If anything, recent data has been on the weaker side of expectations, and growth assets (other than mining shares, benefiting from higher commodity prices) will need stronger cyclical conditions to make meaningful gains.  The key issue for local equities remains whether the current period of slower-than-usual growth is going to turn for the better anytime soon.

The latest official data has been mixed: December quarter GDP growth was a strong 1.1%, but the annual rate of growth was only 2.4%, which means the economy is still growing at the below-3% rates of growth that make little real positive impact on unemployment and consumer confidence. The latest official data also showed a huge rise in corporate profits in the December quarter, but it was a rather lopsided outcome, with mining sector profits, boosted by the recent run-up in commodity prices, accounting for the lion’s share.

Whether the economy can kick on and generate an ongoing across-the-board rise in corporate profits remains debatable.  Both NAB and Westpac analysts noted in their recent updates that they expect solid rates of company growth in the nearer term however 2018 and beyond looked less encouraging due to factors on the horizon such as temporarily higher commodity prices and the residential construction boom fade.  I would note that a lot can change in the ensuing 12 months.

The chart below shows the steadily rising company profit margins (Industrials excluding Financials) since 2014 with projections out to 2018.

Globally, the U.S. has been the strongest of the developed markets, with the S&P500 up 6.5% for the year, but European shares have also been improving as the Eurozone’s economy has strengthened. The FTSE Eurofirst300 Index is up 3.5%, with German shares up 4.6% and French shares, despite the presidential election uncertainties, up 2.5%.

In Japan, however, little has happened since the turn of the year Trump rally, and although the Nikkei Index is formally up 2.4%, the measurement is entirely due to a fortuitous rise between December 30 and January 4. Since then, shares have shown no net change at all.

Emerging markets have been stronger again, with the MSCI Emerging Markets Index up 6.7% in local currency terms and by a strong 9.4% in U.S. dollar terms, as some emerging market currencies have appreciated. Of the big four “BRIC” economies, India (up 10.4%) and Brazil (up 10.3%) did the heavy lifting, with a smaller 4.6% gain in China. Russia, however, lost ground, with the FTSE Russia Index down 9.6%, principally in response to a lower world oil price. Overall, the BRIC economies were up 10.3% in U.S. dollar terms.

Looking ahead though, the outlook for world equities has not changed. The major elements are an improving outlook for global economic activity, but set against high valuations and low preparedness for any adverse surprises.

Sources:  Morningstar research; CBA Research; RBA, Bloomberg, Yield Report, Deutsche Bank.