Month in Review
Global equities enjoyed another good month in October, buoyed by ongoing signs of synchronised growth in many parts of the word, solid corporate earnings and persistent low inflation. Also helping was the failure of various simmering political risks – North Korea, Catalonia and the Trump “Russia probe” – to erupt and hurt investment sentiment.
The MSCI All-Country Equity Index posted a net return of 2.6% in local currency terms, and a stronger 4.4% gain in $A terms – the latter reflecting weakness in the Australian dollar during the month.
Asset Benchmarks Cash: UBS Bank Bill Index; Australian Equities: S&P/ASX 200 Index; Australia Bonds: Bloomberg Composite Bond Index; Australian Property: S&P/ASX 200 A-REITs; International Equities: MSCI All-Country World Index, unhedged $A terms; Commodities: S&P GSCI Light Energy Index, $US terms.
After a disappointing flat September performance, Australia’s S&P/ASX 200 Index also bounced back to post a solid 4% return – despite some soft local data that contributed to a drop in bond yields and lift in bond returns.
Over the past twelve months, the best performing asset class was unhedged international equities, followed by Australian equities. Bonds were the worst performing asset class.
With global growth improving and a continued absence of inflationary pressure – which would cause central banks to withdraw stimulus more quickly – the overall outlook for global equities remains positive. Should US President Donald Trump succeed in securing a tax cut package, this would add to the positive backdrop.
As seen in the chart below, global corporate earnings expectations have been gradually upgraded through 2017 so far (after stabilising in 2016 and downgrades in 2015). Even if earnings growth expectations stabilise at current levels, they’d be consistent with 12% growth in global forward earnings between end-October 2017 and end-December 2018.
That said, with the Federal Reserve likely to raise interest rates further (and almost certainly next month), the European Central Bank recently indicating it would scale back bond purchases next year, and possible US tax cuts, further gradual gains in bond yields remains likely. In turn, this should pressure global equity price-to-earnings valuations.
But by how much? As evident in the chart below, although the forward earnings ratio remains at an above-average level of 16, relative to still low bond yields the forward earnings-to-bond yield gap is still reasonably attractive at around 4%. This suggests scope for the PE ratio to hold up – or at least not fall by much – as and when bond yields gradually rise over the coming year.
Critical to this outlook remains continued low global inflation, which results in only a gradual lift in bond yields. In this regard, it’s worth noting that bond yields have already lifted notably since mid-2016 without as yet much negative impact on stock markets.
Where to invest?
Within equity markets, favoured exposures remains skewed toward international equities – due to Australia’s more muted earnings outlook and likely further weakness in the $A. Indeed, based on current consensus earnings expectations, forward earnings for the S&P/ASX 200 Index are expected to rise by 6% between end-October 2017 and end-December 2018.
As previously explained, the prospective rise in US bond yields also favors the BetaShares Global Banks ETF – Currency Hedged (ASX Code: BNKS). A globally stronger $US should also favor relative performance by Japanese and European equities (available through BetaShares’ HJPN and HEUR ETFs).
Other investment themes for the current market could include buying the $US against the Australian dollar on a view that the $US could gradually strengthen (such as through the BetaShares funds USD or YANK).