Investment

Australian economy bounces back

House View 21 September 2017

It looks like we’re starting to catch up with stronger markets around the world, writes Mark Rider.

After a long period of lagging markets such as Europe and the United States, Australia has bounced back in recent months. Key lead indicators, such as wage growth, show we’re starting to close our underperformance compared to the rest of the world.

Wage growth – 1.2 per cent in the June quarter – is just one indicator of local performance. Others include:

  • Australia’s GDP (gross domestic product) picking up 0.8 per cent in the three months to June according to official gross domestic product numbers from the Bureau of Statistics
  • an impressive 54,200 jobs added in August, as shown by ABS data, seasonally-adjusted – despite expectations of only 15,000.

Investors should take note of the good news this has resulted in for our sharemarket. Most sharemarkets around the world are buoyed by optimistic earnings expectations of the companies listed on them. But not Australian shares, which have already experienced a significant earnings downgrade. So we can be more confident in their valuation.

What matters – inflation and China’s economy

But Australia’s supportive environment for investment returns isn’t yet as strong as the overall global outlook.

Internationally, inflation remains soft, still well below the level central banks across many countries are looking for to start increasing interest rates.

Investor confidence is also strengthening because China, which is critical to the global economy, has strengthened. Data there shows manufacturing is expanding and foreign demand intensifying, with exports increasing. (However, our key leads continue to suggest that tighter Chinese credit conditions will eventually drive softer growth across some sectors.)

Overall, softer inflation and solid growth has made investors comfortable, keeping the sharemarket strong, supporting solid returns to shares, and even lifting the Australian dollar’s value.

As ANZ’s chief investment office has said before, this long into an economic expansion phase we’d expect to see some cracks appearing, pointing to an eventual downturn. But those cracks – exuberant investors, imbalances, and piling corporate debt – are not yet visible.

So central banks, particularly in the US, are not reacting by tightening rates to curb such activity. Indeed, there have been indications that the Federal Reserve is now less likely to raise rates this calendar year due to subdued inflation.

Overall, we continue to expect a supportive environment with only gradual increases in interest rates from levels that are still accommodative, and sharemarkets delivering reasonable but more moderate returns to investors going forward.

Five risks to the global economy

While investor confidence is real, they’re not ignoring longer term issues that could threaten the current equilibrium.

1. Inflation in the United States could force Federal Reserve action in 2018.

2. Assets classes, from shares to fixed-interest investments, are valued quite highly.

3. Manufacturing and earnings momentum indicators appear to be peaking – so there may not be a whole lot of room for growth left.

4. Central banks are expressing some concern about stability due to just how buoyant financial conditions are, ie. things are so good investors might get carried away.

5. The growth of credit in China is falling, meaning less stimulus for that economy.

On balance, we remain neutral in our investment position as we believe the supportive outlook is offset by the current mix of expensive valuations and some complacency in global earnings expectations, relative to Australia.

Investment position at September 2017

Asset class Position relative to benchmark/outlook1
Growth assets - equities Neutral
Australian Neutral
International Neutral
    United States Neutral
    Europe Neutral
    Japan Neutral
    Emerging markets Neutral
Listed real assets2 Neutral
Defensive assets Neutral
Fixed income Underweight
    Australian Neutral
    New Zealand Neutral
    International Underweight
Cash3 Overweight
Currencies  
AUD/USD Negative
NZD/USD Negative
USD TWI Neutral

Notes: 

1. Equities, fixed income and cash are relative to benchmark. Currencies are relative to an absolute return outlook (short term).

2. Comprises of 50/50 split between GREITs and infrastructure securities.

3. Cash is the balancing asset class.