We are of the view that the
nine-year equity bull market is not yet over with global stocks posting modest
gains amid healthy corporate earnings reports and improving outlooks. The momentum of the world’s three main
economies (US, China and Europe) is positive, with growth lifting all nations
through accelerating trade volumes. This positive momentum is likely through to
2018, although the outlook is not without risk. At current
company valuations, the US equity market is susceptible to the Fed starting to
raise the policy interest rate.
Additionally, political risk has been an
increasing feature of the investment landscape in the last 12 months. Recently,
the election-weakened UK government is facing imminent and difficult Brexit
negotiations, US President Trump coming under sustained investigative pressure
from Congressional committees, and deterioration in relations with nuclear
renegade states such as North Korea and Iran, create an environment in which
markets could prove more vulnerable to negative news shocks.
United States
In late July, the Federal
Reserve kept interest rates unchanged and said it expected to start winding
down its massive holdings of bonds "relatively soon" in a sign of
confidence in the US economy.
The
Fed indicated the economy was growing moderately and job gains had been solid,
but it noted that both overall inflation had declined and said it would
"carefully monitor" price trends. Steady job creation in the economy
has pushed the US unemployment rate to 4.3%, near a 16-year low.
China
The annual rate of Chinese
GDP growth has been on a gradual upward trajectory over the past year, rising
to 6.9% in the last quarter to June 2017. Tighter credit conditions imposed
were expected to slow real estate investment. On the positive side retail sales
and industrial production was up 11% and 7.6% respectively. This supports our
contention over the last few years of extreme China angst that the authorities
have the will and the means to support the economy when required.
Japan
Japan’s GDP second quarter
figures showed that it has expanded for the sixth consecutive quarter, led by a
strong rise in private consumption. This may be a positive for the Japan
sharemarket but the BOJ pushed out any chance of rate rises for another 12
months (2019). This points to keeping monetary policy extremely accommodative
for some time yet.
Europe
The region’s economy is
expanding as year on year growth was up 2.1%, the highest level seen since
2011. Confidence indicators are positive and business sentiment is at levels
not seen for a long time. Unemployment across the region is at a nine-year low
of 9.1%, GDP growth is expected to be 2.1% for 2017 and inflation of 1.5%.
A lot of this positivity
appears to be from a pickup in world trade. The Euro has been one of the best
performing currencies over this period increasing against the USD and most of
the main crosses.
It is expected that the ECB’s
monetary policy will begin to ease, but this is not expected to start until
2018.
Australia
The outlook for Australia is
moderate growth over the next one to two years, low inflation and an ‘on hold’
central bank, with the risks to growth still to the downside.
Another positive is that the
decline in resource sector spend will fade and momentum from other sectors
outside of resources will support wage and employment growth in 2018.
The RBA left the cash rate
unchanged at 1.50% in its August meeting with an indication they are in no
hurry to move the cash rate from here, but the next move could be up.
New Zealand
The New Zealand economy has
come through a relatively subdued six months. A series of one-off negatives
impacting the final quarter of 2016 (dairy production) and the first quarter of
2017 (transport and construction) conspired to deliver below trend growth of
0.9% over the six months to March. Two consecutive quarters of low growth begs
the question of where to from here? With financial conditions supportive,
tourism booming and migration strong, we assume a modest rebound over the next
few months to around the 0.7% per quarter we think underlying growth is running
at. A key implication of the recent Monetary Policy Statement is that, if
the economy struggles to reach this growth rate, the Official Cash Rate (OCR)
may have to be cut further to deliver the demand pressures required to hit the
RBNZ’s inflation target.
Summary
Earnings momentum is now
positive for all major equity regions and we expect this to continue, supported
by a solid economic backdrop. A normalising global economy should allow central
banks to unwind their ultra-accommodative interest rate policies. We believe
that long bond yields are set to rise further during 2017 and 2018.
Improving
economic growth around the world will generally support equities and challenge
bonds. That’s because this growth is more ‘traditional’ in nature, arising from
better employment and demand, and thus allowing prices (and potentially
profits) to rise.
For the remainder of 2017 we
are not anticipating further significant upside in either Australasian or
global share markets. Investors are aware of high valuations and may well move
to protect the capital gains in their portfolios, rather than take on
additional risk. An alternative scenario – market ‘euphoria’ in which investors
simply become too complacent and push markets up into a climax marked by
narrowing leadership and mounting volatility – remains a distinct risk, but it
is still not our main case. This assessment could change if monetary policy
normalization were to be interrupted and put on hold yet again, whether for
economic or geopolitical reasons. Given the clarity with which the major
central banks are now preparing markets ahead of policy moves and the
robustness of the global expansion, any significant interruption seems
unlikely.
