Summary of key points


  • Over the last few weeks, equity market valuations deteriorated slightly in the USA, Australia and Europe as bond yields increased while long-term earnings per share growth estimates were maintained or reduced only slightly
  • .In spite of the recent increases bond yields are still at low levels by historical standards. This means that Australian and US equities are still fairly priced based on a long-term horizon. The main recent events of significance have been:
  • ◦ The Reserve Bank of Australia maintaining its official rate unchanged at 1.5% p.a. but indicating that it now considered the neutral rate to be 3.5% p.a., hence foreshadowing a series of increases to this level over some unspecified period. This added to the upward pressure on bond yields and consequent downward pressure on equity market prices, particularly in interest sensitive sectors such as listed property trusts.

    ◦ APRA, the Australian bank regulator, announced its long awaited policy change in the minimum capital requirements for banks. It was less onerous than widely expected and it is unlikely that the banks will have to have new issues of capital beyond dividend reinvestment. On the day of announcement, the equity market liked it, with bank stocks rising between 2.5% and 3.0%, more than recovering the losses seen in the run up to the policy change.

    ◦ System wide growth in bank lending on residential property picked up in June, increasing at an annualised rate of over 7% p.a. This growth, in what is the single largest asset base of the banks, helps underpin growth in their earnings per share and dividend per share. These are critical to any assessment of whether the banks are fairly priced or otherwise. The banks appear to be fairly priced, assuming EPS growth of between 3.25% and 3.75% p.a. over the next ten years.

    ◦ The Chairman of the Federal Reserve, in testimony to the US Congress, indicated that it would be more cautious in tightening monetary policy due to inflation and wages growth continuing to fall short of its expectations. This helped reduce US bond yields slightly and spur the US equity markets to new record highs.


◦ Chinese GDP growth exceeded expectations coming in at 6.9% p.a. versus the planned 6.5% p.a., but this was accompanied by a very explicit warning from President Xi that action will be taken to rein in the rate of credit growth. While no real action on this is expected until after the election in November, the threat was enough to cause a 4% sell off in Chinese equities.

◦ Continued weakness in the oil price which reflects the structural weakness of OPEC, complicated by a serious political dispute among the Gulf nations. The depressed oil price is a factor contributing to low inflation in the more developed economies. The capacity for US shale oil producers to operate profitably at $US 60 per barrel puts an effective cap on the oil price.

  • Our valuation work combined with an updated assessment of the momentum and qualitative factors indicates that it is still appropriate to hold a neutral or benchmark allocation to Australian and International equities.
  • Given the prospects for further bond yield increases over the next two years there should be a major underweight to listed property and an underweight to fixed Interest combined with a shorter duration position in fixed interest.

Risk factors to be aware of include:

  • A significant loss of confidence in US equities due to the legislative program of the Trump administration stalling in Congress due to the unique blend of skills and talents employed by the new President’s team. In particular the delays seen in regard to healthcare may spread to its tax reform agenda.
  • A stalling in economic growth in China if credit and lending is cut back too soon or too sharply. • The biggest threat to equity market returns is the effect of rising interest rates, which will eventually come, adding to the debt servicing costs on what is now a large volume of debt worldwide. Global debt now stands at $US217 trillion or 327% of world GDP


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