By Jeff Mitchell, Head of Investment Research, Australian Unity Personal Financial Services
Global share markets are being supported by improving economic data and improving consumer sentiment.
Share market reactions to a recent US rate rise were positive and the prospects for further rate rises this year are being viewed as evidence that the US economy is expanding under its own steam.
Australian and US share market valuations are higher than historical levels but improving earnings growth estimates provide some justification for them,
Elsewhere, European data releases have been broadly positive but valuations remain low, reflecting slightly higher risk in the region.
The US a key driver of global share markets
The global economic landscape continues to be directed by the US as the world’s largest economy.
Donald Trump remains a big X factor as much store has been placed in his policies which are clearly expansionary. Trump recently hit his first stumbling block in trying to ratify policy which has caused some consternation about whether he will be able to get through future expansionary policies such as tax cuts and infrastructure spending plans.
If he can’t enact his policies, the outcome may not be as positive as markets hope for, but barring any other catastrophe the US economy could continue its expansion and the US central bank could continue to raise rates as long as economic data remains supportive.
A definite theme globally is one of political gridlock in which governments are struggling to pass their policy agenda. While Trump and other political leaders’ inability to pass their proposed expansionary policies may cause equity markets to recalibrate earnings growth expectations, there is ample data to suggest that consumer confidence continues to rise (see Chart 1) and sustainable earnings growth is achievable.
While we don’t expect equity markets to have a repeat of the past year, US valuations, while elevated, are not stretched dangerously by our assessment and remain attractive in other parts of the world.
Chart 1: US consumer confidence rising
Nationalism trend may be waning
While not seen as an economic positive globally, nationalism and protectionism certainly came to the fore with the Trump and Brexit votes.
Some evidence is starting to appear, however, that the strength of this movement may be reaching a high water mark.
The recent Dutch election result showed a lower than forecast level of support for a far right wing candidate than could be expected under a populist movement. Voter turnout was higher than historical averages providing extra weight to the outcome.
All eyes will be on the French election to see if a similar outcome eventuates.
A trend against nationalism and protectionism could be positive for global share markets.
Australian growth still reliant on China
For Australia, the reality of our geographic coastal borders, our floating exchange rate and dependable trade agreements mean that the factors discussed above remain at the margin rather than being likely to have short term dire consequences for our economy.
Australia’s fortunes are more tied to the ongoing growth in China which, from all reports, continues to expand at 6+% p.a.
China-destined Australia exports continue to make up a large proportion of total exports (see Chart 2). We are comfortable with Australian Chinese trade deals and expect the mutual benefits to accrue to both economies.
Chart 2: Australian Exports by destination
Australia’s stable regulatory environment, independent central bank and enviable record of GDP growth remain attractive to offshore investors. Although interest rates in an absolute sense are low, on a global basis they are relatively high which will provide some support for the Australian dollar.
While sustainability of current debt levels globally can be questioned, in Australia’s case it is more an issue for households than the Government per se. The biggest providers of capital to our household sector are the big banks and they are closely monitored by our regulators.
Given the relatively strong capital position of the banks, even a fairly severe bout of defaults is not forecast to unduly stress the banking system. The banks may very well continue to tighten lending standards and an increase in defaults by borrowers may result. However, we expect loan losses to remain subdued due to widespread asset price improvements, low unemployment, elevated commodity prices and favourable conditions for the agriculture sector.
Australian residential property market possibly over-valued in key areas
The Australian housing market could arguably be described as a bubble in major centres particularly Sydney and Melbourne, but while interest rates remain at or near current levels and the supply demand balance remains skewed in favour of supply, a deflating of this bubble could be a while off, and likely more in the apartment market than in housing initially.
Furthermore, these low rates will continue to support the equity market and should rates continue rising, they could in the short term provide further support as capital flows from bonds to equities driven by positive sentiment toward economic growth.
Overall the relatively high valuations in the Australian property market and its strong recent performance warrants caution. While we believe there may be a correction at some point which could be swift, at present conditions remain favourable toward attractive long term market returns.