Markets, News, Views, Commentaries. (May 2016)

World equity markets, after recovering from February through to late April, have softened again more recently in another episode of uncertainty over global growth prospects, especially in the eurozone and Japan. While the global economic outlook remains modestly positive, it carries several downside risks, and recurrent outbreaks of anxiety may well feature during the rest of this year. Global bond yields have dropped to even lower levels again, and now look more likely to stay at these ultra-low levels for some time.

Local equities have modestly outperformed global equities, as the latest data on the prospects for the Australian economy have generally been positive. The Reserve Bank of Australia, or RBA, looks likely to cut interest rates again, after its surprise cut earlier this month (more in the story below).

Most forecasters expect the lower interest rate track now likely in Australia will translate into a lower track for the Australian dollar with NAB, Westpac and ANZ currently predicting levels of between USD$0.73 and USD$0.66 by the end of 2016.   But forecasting currency movements is notoriously difficult and there is a minority view that other factors such as commodity prices, Chinese growth, or the dividend attraction of Australian equities or listed property could outweigh the impact of lower local interest rates.  You may have noted in last month’s Newsletter that the Commonwealth Banks sits in the latter camp, with a current forecast of between USD$0.78 and USD$0.80.

As for Australian shares, recent data shows an economy that is either continuing to grow at a reasonable rate, though still suffering the side-effects of lower mining investment, or even picking up a bit from its recent rate of growth. Although the RBA’s cut in interest rates on 3 May might at first suggest the economy needed some stimulus, the move was very largely focused on unexpectedly lower inflation rather than on any serious slowdown, with the RBA saying “the available information suggests that the economy is continuing to rebalance following the mining investment boom” and “Indications are that growth is continuing in 2016, though probably at a more moderate pace” than in late 2015.

However, once again, the key issue for investors is whether share prices are aligned with the likely profit outlook from this reasonably promising economic backdrop. As it happens, we got a good steer on likely profits growth in the 3 May Budget—Treasury included its latest forecasts of growth in pre-tax and pre-depreciation corporate profits (it prepares them because it needs to forecast the company tax take).  Treasury expects GDP to have grown by 2.5% in the current fiscal year to June 2016, by 2.5% again in the

year to June 2017, and by a faster 3.0% in the year to June 2018. It expects this GDP growth to translate into corporate profits growth of 5.25% in the year to next June, and by 5.75% in the year to June 2018, with ongoing modest growth thereafter (5.25% in the year to June 2019, 4.75% in the year to June 2020).

In relation to Global shares, the global economic outlook continues to be idling rather than strong.  As an overall group, the emerging markets look set for rather more substantial rates of economic growth, albeit with very large differences at an individual country level, and with higher degrees of political risk involved for investors minded to access their better economic prospects.   US data has ranged from mixed to good, but the outlook in the Eurozone and Japan is less upbeat, China has assorted problems though its economy is expected still to grow at very sound levels of 6.5% this year and 5.9% next year [The Economist, May 2016] and forecasters expect India to do very well with growth in the 7% range over the next two years.

Note though that even if the overall economic performance of the emerging markets delivers for investors, the level of geo-political risk remains high.

Sources:  Morningstar research/Economic Update May 2016; RBA.