Markets, News, Views, Commentaries

Bond, equity and property markets have struggled in recent months with the prospect of higher interest rates in the United States—valuations across many asset classes had been inflated to expensive levels by very low interest rates. The readjustment of valuations is likely to remain a key theme in coming months, though the headwinds are moderated to some degree by ongoing growth in the global economy and by the likelihood that bond yield rises will be modest and gradual. At home, there are some signs that the pace of growth of the economy may be picking up, but local assets also look expensive and are likely to go through the same rethink of value on offer.

In Australia, shares have been volatile. Prices had been sliding in August, dropped sharply in the first half of September on global interest rate concerns, rebounded in later September, but more recently, have started to drift down again. The net result is that the S&P/ASX 200 Index has recorded a small year-to-date capital gain of 1.8%.

There is still no definitive sign of a breakout from slower-than-usual growth in business activity, though a case may be building for a gradual turn for the better.   The mining sector, where the wind-down of investment spending has been a major drag on overall economic performance, may be cautiously considered to be on the mend. The rest of the economy is also, arguably, looking a bit better. Perhaps the most optimistic indicator came from Dun & Bradstreet’s latest (October) survey of business expectations, which was notably upbeat: “The upswing for expected sales, profits and employment has been sustained in the most recent survey, aided, it would appear, by the record low interest rate settings and evidence of policy progress from the re-elected Turnbull government.”

Research house Morningstar described it thus: “the outlook overall looks to be cautious optimism about a gradual improvement in the economy, or as the RBA put it in the minutes to their latest monetary policy decision on Oct. 4, ‘There was a reasonable prospect of sustaining growth in economic activity that would support further employment growth and, in time, a gradual increase in wage growth and inflation. At the same time, however, there remained considerable uncertainty about momentum in the labour and housing markets’.”

Globally, share prices, after weakening in September principally on fears of higher U.S. interest rates, have continued to drift down in recent weeks. The MSCI World Index is now showing only a marginal capital gain year to date of 1.1% in the currencies of its component markets, and of 1.5% in U.S. dollar terms. But local investors will have gone slightly backwards, due to the Australian dollar’s 4.0% appreciation against the U.S. dollar.

Global equity investors’ attention has been heavily concentrated on the U.S. market, as it has been the cornerstone for overall global equity performance.  However, it has not been easy to get a clear read on America’s prospects. Recent data on the U.S. economy has not been consistently strong or weak, leaving the Fed (as well as equity investors) somewhat in the air about the American economy’s ability to absorb less supportive monetary policy – that is, the Federal Reserve interest rate hikes that have been on-again/off-again for much of 2015 and 2016.

The most likely outlook is for ongoing but subdued growth, with the latest (October) Wall Street Journal poll of U.S. forecasters on average picking GDP growth at a 2.0% to 2.5% rate over the next year—not spectacular, but not shabby, and suggestive of modest prospects for corporate profit growth.

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Sources:  Morningstar research/Economic Update October 2016; RBA, Bloomberg.