Despite somewhat cautious sentiment and negative headlines at present, consensus analyst forecasts are for the Australian S&P 200 index to grow earnings by 7.2 per cent this year and pay a dividend return of 4.6pc.
However, where we are cautious is the price investors are paying for stocks in certain segments of the market, which remain elevated. This can indicate heightened expectations for future earnings growth or that investors are willing to pay more for less. We think it’s a combination of the two, where expectations continue to improve as underlying fundamentals remain sound and the lack of alternatives (i.e. low interest rates) have pushed investors up the risk curve. We think this is a key area to watch and stocks falling short of expectations will be treated harshly by the market.
The world economy continues to perform well. Economic trends suggest that growth this year will match that of last year. In developed markets, strong labour markets are slowly lifting wages. In the US and the UK, retail sales volumes are growing faster than last year. In Europe, volume growth rates are generally slightly slower, but still good. This is a generally positive background for risk assets, but investment outcomes have become highly dependent on ongoing gains from US equities.
The most likely outlook in our view is ongoing global expansion, though trade wars, monetary policy mistakes, wobbles in emerging markets, and geopolitical shocks are all real risks to monitor. Bond yields in the US have headed higher recently and have contributed to weak performance in global fixed interest and global income oriented assets like property and infrastructure.
In the Australian economy, it looks as if the pace of business activity may be moving into a slightly higher gear, although the ongoing drag from the Financial Services Royal Commission remains a concern for the financials sector’s equity performance.
There was also a pleasant surprise when the June quarter GDP data were released. The economy grew at a faster than expected, 3.4pc in the year to June, well above the 2.9pc that forecasters had been predicting, and the news extended the already record-breaking economic expansion to 27 years.
One quarter’s data might not represent a change in the trend. But it was an encouraging signal, and more recent data have generally confirmed that business activity is going well. The latest (September) business survey from National Australia Bank, for example, found that “Business conditions regained some of the ground lost in recent months and have been well above average for some time”.
Despite the optimism in corporate Australia, equity market valuations remain stretched and measures of market volatility remain close to their all-time lows. We continue to caution investors against complacency and note that avoiding loss is just as important as achieving profits in the current market.
- Justin Still Investment Adviser (Authorised Representative: 000279726) Morgans Financial Limited | ABN 49 010 669 726 | AFSL 235410