Nine reasons to be optimistic about shares
The past few months have been messy, with Brexit, the Australian election, another terrorist attack in France and an attempted coup in Turkey. Indeed, the past 12 months have been messy, starting with the latest Greek tantrum and China sharemarket plunge a year ago.
It’s almost as if someone has listened to Taylor Swift’s song ‘Shake It Off’ and decided to try to shake up investment markets.
This has all brought a rough ride for investment markets, with most sharemarkets falling into bear territory at some point over the past year and bond yields plunging to record lows.
This article reviews the worry list of the past 12 months and the impact on returns, and looks at the outlook.
The past year has had a long worry list:
- Another Greek tantrum in June-July last year.
- A 49 per cent plunge in Chinese shares with worries about debt, growth and capital outflows as the renminbi was devalued.
- An ongoing collapse in commodity prices.
- Intensifying concerns about deflation.
- Recession in Brazil and Russia and concerns about a new emerging-markets debt crisis.
- Worries about energy producers defaulting on their loans.
- Ongoing angst about the end of the mining boom and the risk of a property crash in Australia.
- A slump in manufacturing globally, led by the US and China.
- Concerns that the Fed raising rates and causing a further surge in the US dollar would accentuate problems for China, the emerging world and commodity prices.
- Another soft start to the year for US growth.
- Falling profits in the US, Australia and most regions.
- Numerous IS-related terrorist attacks.
- Worries about a potential Donald Trump US presidency.
- A “surprise” vote by the UK to leave the European Union (Brexit), setting off a new round of fears that there will be a domino effect of countries seeking to leave the eurozone.
- A messy election result in Australia with possibly an even more difficult Senate that will make it even harder for the Government to control spending and implement reforms.
- An escalation of tensions in the South China Sea.
- An attempted coup in Turkey.
The success of Donald Trump in the US, the Brexit vote and the close election in Australia highlight a growing angst at rising inequality and a loss of support for the economic rationalist policies of globalisation, deregulation and privatisation.
While understandable, the resultant populist policy push risks slower long-term economic growth and lower investment returns.
Constrained, uneven returns
The turmoil over the past 12 months has shown up in very messy sharemarkets (most falling into bear territory with 20 per cent or more falls from last year’s highs to their lows early this year before a rebound) and a sharp decline in bond yields to record lows.
However, unlisted assets such as commercial property, infrastructure and listed yield-based plays like real estate investment trusts have done well. Reflecting the constrained environment, balanced growth superannuation funds saw average returns of around 1 to 2 per cent.
Source: Thomson Reuters, AMP Capital
Nine reasons to be optimistic
1.- Global growth is OK. There has been no sign of the much-feared global recession. Global business conditions surveys point to ongoing global growth of around 3 per cent. In Australia, growth has in fact been particularly good at around 3 per cent. The economy has rebalanced away from a reliance on mining and it has benefited from the third and final phase of the mining boom, which has seen surging resource export volumes.
2.- Central banks have signalled easier monetary policy for longer post-Brexit. This is likely to ensure that liquidity conditions remain favourable for growth assets.
3.- The shift to the left by median voters in Anglo countries could actually boost growth in the short term (including under Trump in the US) as it sees a relaxation of fiscal austerity.
4.- We may have seen the worst of the commodity bear market. After huge 50 per cent or more falls, some commodity markets are moving towards greater balance (notably oil and some metals).
5.- Deflation risks look to be receding. Oil prices, which played a huge role in driving deflation fears (sustained lower prices), look to be trying to bottom, and a move towards more inflationary policies by governments and some central banks is likely to start shifting the risks towards inflation on a two to five-year view.
6.- The profit slump may be close to over. US corporate profits are showing signs of bottoming, helped by a stabilisation in the US dollar and the oil price. Australian profits are likely to rise modestly in the year ahead as the commodity-price-driven plunge in resource profits runs its course.
7.- Latest falls in interest rates and bond yields have further improved the relative attractiveness of shares and may unleash yet another extension of the search for yield.
8.- Investors have been more relaxed about the latest decline in the Chinese renminbi. This reflects slowing capital outflows from China, reassurance from Chinese officials and a growing relaxation about fluctuations in the value of the RMB.
9.- All the talk has been bearish lately. Brexit, Chinese debt, US slowing, messy Australian election – which provides an ideal springboard for better investment returns.
What about the return outlook?
The August–October period can often be rough for shares. But looking through short term uncertainties and given the considerations noted above, it is hard to see the outlook for investment markets differing radically from what we have seen over the past few years, albeit stronger than over the past 12 months for shares.
Growth is not flash but OK, inflation is low and monetary conditions overall are set to remain easy. For the main asset classes, this has the following implications:
- Cash and term deposit returns to remain poor at around 2 per cent. Investors remain under pressure to decide what they really want: if it’s capital stability, stick with cash; if it’s a decent stable income flow, consider the alternatives.
Source: RBA, AMP Capital
- Ultra-low sovereign bond yields of around 2 per cent or less, with a third of the global bond index in negative-yield territory, indicate the return potential from bonds is low.
- Corporate debt should provide OK returns. A drift higher in bond yields is a mild drag, but with continued modest global growth the risk of default should remain low.
- Unlisted commercial property and infrastructure are likely to benefit from the ongoing search for yield.
- Residential property returns are likely to be mixed, with some cities continuing to see price falls and a further slowing in Sydney and Melbourne property prices. Very low rental yields are not good, particularly in oversupplied apartments.
- The rising trend in shares is likely to continue: shares are OK value, monetary conditions remain very easy and continuing moderate economic growth should help profits. Within shares, we favour European, Japanese and Chinese/Asian over US.
- Finally, the downtrend in the Australian dollar is likely to resume, enhancing the case for global shares (unhedged for currency movements).
Things to keep an eye on
The key things to watch over the year ahead are:
- Global business condition Purchasing Managers’ Indices (PMIs) – these currently point to constrained but OK growth.
- Signs of European countries seeking to leave the eurozone and investors demanding higher borrowing rates to lend to countries such as Italy, seen to be at risk of leaving. Italian banks are also a risk worth keeping an eye on.
- When/if the Fed starts to raise rates again later this year and the impact on the US dollar.
- Chinese economic growth readings.
- Whether Australian non-mining activity keeps improving.
The September quarter is historically a rough one for shares and the prospect of a Trump victory in the US and worries about Italian banks may cause some nervousness.
But looking beyond near-term uncertainties, the mix of reasonable share valuations, continued albeit constrained global growth, easy monetary conditions and a lack of investor euphoria, suggest returns are likely to improve from those over the last year.
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