Many asset classes, both at home and overseas, ran into heavy weather over the past month principally because markets started to confront the reality rather than the distant prospect of more-normal monetary policy in the United States – the long anticipated interest rate rises in the US look more and more likely to happen. Many asset valuations had made sense only when interest rates looked likely to remain very low and thus were vulnerable when the tide started to turn. There are likely to be further episodes of volatility in coming months as investors continue to rethink asset prices against a background of only modest global economic growth.
Research house Morningstar notes that without support from a strong Australian economic cycle, Australian shares were not well placed to cope with the global equity sell-off this month. Australian shares had gone sideways for most of August and were slipping in late August and early September even before global concerns kicked in.
Looking ahead, the latest official figures on the overall economy have been good, with GDP growing by 0.5% in the June quarter and by 3.3% year on year. The weak spot for Australian shares is likely to be the collateral damage from further episodes of external volatility. There have already been three instances this year where global equities were roiled by one concern or another (global growth/China, Brexit, and U.S. Fed policy). There are likely to be further squalls along similar lines, and the domestic business cycle is not robust enough to enable Australian shares to ride out any future global sell-offs. Australian equities may well continue to struggle to make positive headway until there is evidence that local economic activity has finally broken free of the post-mining-project slowdown.
Globally, investors in recent weeks have become more concerned about the prospect of higher interest rates in the U.S, and their concerns have spilled over into global equity markets. Investors have been questioning the ability of the U.S. economy (which has been one of the ongoing engines of global growth) to cope with increasing interest rates, and they have also had to confront the potential for tighter monetary policy to upset the relative valuations of bonds and equities. Ultralow interest rates have been one element in driving share markets up to expensive levels by historical standards.
The reaction is somewhat surprising given rates have been on the verge of a rise for some considerable time and, in any case, would typically coincide with strengthening economic data and an increasingly ‘hot’ economy. But recent job numbers and industry surveys have suggested that the rate of growth of the American economy is slowing a little if anything and so December seems the soonest another interest rate adjustment might occur.
On a more “glass-half-full” view, ongoing (if slower) growth in the nonmanufacturing parts of the U.S. economy has made up for the setback to manufacturing, and the overall economy is still growing: August marked the 85th month in a row of growing activity.
Further, Morningstar states pretty confidently “the world economy will push through the current spot of cyclical weakness. Forecasters (as surveyed in The Economist’s September international poll) are still predicting that the developed economies will post some growth next year. However, the anticipated growth rates are modest: 2.0% in the U.S., 1.2% in the Eurozone, and even less in Japan (0.8%) and post-Brexit Britain (0.5%). Emerging markets will do rather better—both Brazil and Russia will emerge from recession, while China and India will continue to register rapid growth.”
Sources: Morningstar research/Economic Update Sept 2016; RBA, Bloomberg, AMP Capital.