Summary of key points
- The main drivers of returns are equity market returns. In turn the main drivers of returns on equities are low bond yields (even though these will have a tendency to rise) and reasonably solid earnings growth.
- Over the latest month, equity market valuations have improved slightly in the USA, Australia and Europe as bond yields declined and long-term earnings per share growth estimates were maintained.
- The main events of the last month were:
◦ The Federal Reserve increasing its Fed Funds Rate as expected by markets- so no adverse impact.
◦ US deleveraging since the GFC appears to have stopped and may be turning around, leading to more support for corporate earnings growth.
◦ The Japanese economy has moved out of deflation improving the outlook for corporate earnings growth. Higher dividend payout ratios following government pressure are adding further to the stock price outlook.
◦ European Central Bank reaffirming a policy of very slow scaling back of its major monetary stimulus
◦ The French election confirming the power of newly elected President Macron and consolidating the forces in favour of preventing a break up of the Eurozone, which would be very disruptive to global financial markets.
◦ Periods of equity market weakness resulting from political factors, but proving to be transient.
◦ Chinese growth continuing but with more emphasis on services versus manufacturing, indicating some increase in resilience in GDP growth.
◦ A major fall in the oil price showing the structural weakness of the OPEC attempts to boost prices by limiting production. This will reduce the level of inflation worldwide and reduce the risk of an inflationary overshoot caused by continued monetary policy stimulus. Overall positive for most equity market sectors but not for the energy sector.
- Our valuation work combined with an 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 and an underweight to Property and Fixed Interest.
- Delays in the implementation of the tax cuts in the USA due to distraction of the Congress by issues relating to the possible impeachment of the President. There is also the risk of stalling the continuing budget resolution that may cause a Federal government shutdown at the end of September.
- Any economic policy mistake in China such as reducing credit and lending to loss making state enterprises too much or too soon.