The remarkably prescient Glenn Stevens has given his latest summary of global and Australian economic conditions, continuing his cautiously optimistic predictions of steadily improving economic conditions in Australia and overseas at last week’s Credit Suisse Asian Investment Conference. Stevens (reflecting the RBA official view) made three key points of relevance for Australian investors:
- Australian inflation and interest rates are now expected to be on hold for a period of time
- The Australian housing sector (especially new construction) is expected to continue to grow strongly
- Economic reforms are expected to help drive economic growth, driven here by the new Abbott Government, and across the developed world, by the recent pledges of the G20 nations to implement measures to add 2% p.a. extra GDP growth to current levels.
What does this mean for Australian share market investors?
Share market returns are driven by several factors, including:
- Fundamentals (e.g. the earnings quality and growth of listed companies)
- Relative returns between “risk free” investments like cash deposits, versus stocks
- Market sentiment (recall that the great economist John Maynard Keynes was fond of saying “the market is what people think it is”).
Stevens’ comments illuminate each of these factors and how the RBA expects them to play out in coming years.
Regarding economic and corporate fundamentals, Stevens spent much of his speech considering the impact of the slowdown of the resource sector’s massive contribution to Australia’s terms of trade. He noted that this contribution peaked 2 ½ years ago, but that strong resource sector incomes should continue for some time, driven by China and growing global demand. Noting the emerging pessimism about China, Stevens countered by noting:
“China’s economy grew close to, and in fact a little faster than, the government’s target last year. Strong and about equal contributions to growth were made by household consumption and investment. Consumer price inflation continues to be stable.”
He saw similar strength in Asia, and the US:
“Around the Asian region generally, at this stage, our sense is that economic growth is continuing at about its trend pace…” and
“The United States continues its recovery led by private demand, and over the second half of last year the economy expanded at an annualised rate of just over 3 per cent…there is no obvious reason to expect that the expansion will be derailed.”
These comments highlight the general improvement in global and Australian economic conditions, which are a necessary condition for improving corporate fundamentals. Not all companies increase profits when economic conditions are good – but this certainly helps good companies do better. These conditions also help market sentiment – good sentiment helps encourage risk taking, including increased investor exposure to the share market.
Regarding Australian conditions, Stevens noted:
“There are some promising signs… Recent data shows stronger household consumption over the summer. The latest surveys and our own liaison confirm this, and suggest that retailers are more optimistic than they were a year ago. That said, we expect consumption spending to grow in line with income or perhaps a little faster, but not at the pace seen in the years prior to the financial crisis.
We certainly see abundant signs of confidence in the housing market. Dwelling prices have seen a broad-based rise of 10 per cent in the past year and are now about 5 per cent above the previous peak in 2010.
So there is encouraging early evidence that the so-called ‘handover’ from mining-led demand growth to broader private demand growth is beginning. Putting all this together, we think economic growth will continue, and may strengthen a little later this year and pick up further during 2015.”
The weight of cash
The third major factor driving share markets – relativities between cash rates and stock market returns – is likely to continue to play out in favour of steadily increasing investment into Australian stocks. Australian interest rates are at a 30-year low and, based on Stevens’ comments, are likely to remain low for the foreseeable future:
“Our monetary policy settings have been unchanged since last August, at what by any standard is a very accommodative level. This is playing its part in supporting sustainable growth in demand, consistent with the inflation target. We have signaled that if the economy evolves in line with the present set of forecasts, a period of stability in interest rates could be expected.”
In summary – with the expectation of continuing low interest rates, improving economic conditions (a good backdrop for improving corporate fundamentals) and improving market sentiment, the Australian stock market seems poised to continue its steadily improving performance. However, investors must remain vigilant and look to buy quality stocks at good prices.
BetaShares is the issuer of a broad based “Fundamental Index” ETF (ASX code: QOZ) which invests in the top 200 Australian stocks based on fundamental value. This can be an efficient way to invest in the Australian stock market using a fundamental valuation-based approach, seeking to take advantage of steady improvements in the broader equities market and reduce exposure to ‘overheated’ stocks – you can read more about the theory of fundamental indexing here.