Geopolitical tensions are on the rise again as North Korea goads the US with its missile tests and aggressive rhetoric. The outcome of this situation is impossible to predict but it is a factor that has the potential to cause periods of market volatility in coming months.
US shares are benefiting from stronger earnings growth as the global economy improves. ISM Index data released just after month-end suggest the US manufacturing sector is the strongest it has been in over 13 years and the recent US dollar weakness is also supportive. Monetary policy concerns are also occupying investors’ minds, with most economists expecting at least one more rate rise in 2017. As always, the pace and timing of further interest rate rises will depend on the incoming economic data. Investors are also focused on the unwinding of the Federal Reserve’s extensive quantitative easing programme, which will commence in October. Whilst the move towards quantitative tightening will likely be gradual, the subsequent impact on bond yields will be a key factor to watch in coming months.
Recent data in Europe suggest the recovery is much stronger than previously anticipated and this bodes well for corporate profits. Whilst share markets in the region should continue to be supported by the liquidity effects of the European Central Bank’s accommodative monetary policy, including its quantitative easing (QE) programme, accelerating growth is prompting investors to debate the likely end of QE and a possible turn in the interest rate cycle. Politics remains a key risk given Italy’s unstable political environment, the ongoing Brexit process and Catalonia’s push for independence from Spain.
Signs of an improvement in growth are finally emerging in Japan, with five consecutive quarters of positive GDP growth and a pick-up in industrial production. This has started to support share market sentiment as it improves the outlook for domestic corporate profits. Japan’s share market is also leveraged to weakness in the yen which improves the competitiveness of Japan’s large listed export sector. This suggests the market may find it hard to rally further whilst the US dollar is on its current weaker trend.
The strength of the Chinese economy is hard to gauge at present. Although infrastructure spending remains robust, the government is engineering a slowdown in the property market via tighter liquidity and macro prudential restrictions. PMI data have rebounded over the past three months but recent industrial production and retail sales data have been mixed. Tentative optimism has boosted commodity prices but a sustained rally is likely to require more ongoing evidence of an improvement in Chinese growth.
Australia’s August Reporting Season was reasonable, with only modest downgrades to the FY18 earnings outlook. This should provide some support to the market although there are also several headwinds to contend with. These include:
- the strength in the Australian dollar which is undermining the outlook for companies with offshore earnings;
- investors’ concerns about a sharp slowing in the domestic property market which would likely reduce consumption and constrain growth; and
- the pending entry of Amazon into the Australian market which has contributed to a significant de-rating of retail stocks.
The resource sector has rallied in response to better Chinese growth data and stronger commodity prices although for this to be sustained, the Chinese economy will need to show ongoing signs of improvement. From a valuation perspective, the overall market is still quite fully valued according to Goldman Sachs data, trading on a PE of around 15.2 times which is 5% above its 20-year average.
This publication is produced by the MLC Investment Policy Team and issued by MLC Wealth Management Ltd and its related companies and entities for the intended informational use by financial advisers. Whilst due care has been taken in preparing this report, Australian National Consulting, ANC Wealth and MLC does not warrant or represent that the information, opinions or conclusions contained in this report are accurate, reliable, complete or current. This report is general information only and has been prepared without taking into account an investor’s individual objectives, financial situation or needs. The report should not be taken to contain securities advice or recommendations. Past performance is no indication of future performance.