Recovery Rally Lessens Investor Gloom, As Recession Worries Recede
Shane Oliver, head of investment strategy and chief economist at AMP Capital, is not bullish on markets, but nor is he overly bearish. Oliver, who leads a team that invests $50 billion in assets, says the dynamic asset allocation process that AMP uses is “telling us to reallocate to equities.”
“We see share markets higher in a year or so. At home, low interest rates, low petrol prices, the boost from the low $A, the improved performance of ‘low-mining’ states like New South Wales and Victoria, and the likelihood that the slump in mining investment is getting close to the bottom are reasons not to get too gloomy on Australia and Australian assets,” he says.
Coming in to the new year, says Oliver, share markets were under a lot of pressure, with persistent worries about the prospects of a global recession, US recession, China’s slowdown, European banks, the emerging markets, the weak oil price and Australian house prices. But a lot of the worries on the “worry list” from earlier this year have faded, he says, resulting in the “recovery rally.”
Concerns about China have settled a bit following indications it will provide more stimulus support; the Chinese renminbi has stabilised; the $US has stopped rising; the Fed has become more dovish; fears of a US recession have faded with some better manufacturing data; oil and commodity prices have moved higher; credit spreads have narrowed a bit as fears of significant corporate defaults have receded; and in Australia, the economic news has been OK,” he says.
“Global growth is uneven, but we won’t go into recession. We see 2016 as another year of constrained growth. We’re looking for global economic growth at about 3 per cent; China at about 6.5 per cent, down from 7 per cent last year; and the US about 2 per cent, which is the norm since the GFC ended. The Federal Reserve would like to see 2.5 per cent, but in saying that US rate hikes will be data-dependent and gradual, the Fed is clearly indicating that it is not going to do anything to consciously threaten the global and US outlook,” says Oliver. “We see growth in the Eurozone of about 1.75 per cent, and Japan 1 per cent.”
February’s recovery rally has continued into March, helped by a combination of the Fed further delaying interest rate hikes and mostly good economic data. “A risk in recent times has been that a too-aggressive Fed will threaten the global outlook by further pushing up the US dollar, which in turn would threaten US growth, put more downwards pressure on oil prices (and hence energy producers), and add to the risk of a funding crisis in the emerging world (as some emerging country borrowers struggle to service US dollar denominated debt).
The more dovish interest rate outlook displayed by the Fed in March is “supportive for shares and growth assets,” says Oliver, and should lead to an ongoing stabilisation in the value of the US dollar.
Importantly, China has not had a hard landing, and recent comments by the governor of the People’s Bank of China (PBOC) and the nation’s Premier indicate that Beijing is ready to take decisive actions if needed. “China’s growth has slowed, but not collapsed. hard landing would be growth in the 2 per cent–4 per cent range – if that were, private business surveys would be a lot weaker than they’re actually reporting.
“If you average the official and unofficial surveys, they’re basically going sideways with a slight downward drift. So growth is drifting downward, but it’s not crashing. Chinese property prices were falling, but they have stabilised. It’s not as strong as it used to be, but it’s OK,” says Oliver. The European Central Bank (ECB) has also stepped up its stimulus efforts, he adds.
Global business indicators around the world have slowed down, but they’re nowhere near as low as in the GFC. “Manufacturing is weak, but services is much better. Our base case is that shares should provide a decent return as global recession is avoided,” says Oliver.
At home, Oliver says the Australian economy is “still motoring along,” growing at 3 per cent. “That’s not a bad outcome for an economy that was whacked by the end of the biggest boom in its history. Overseas they thought that we would have a recession, but it hasn’t happened.
“I’m wondering whether I am too pessimistic on Australia. My view has been that the Reserve Bank of Australia (RBA) might need to provide more help for the Australian economy, with another rate cut, and the A$ has to go to 60 cents. We think there is still the risk that the A$ will go lower – it has been surprisingly stable lately, but my base case is that it has to lower, and therefore you need to have some of your money in offshore shares.”
Low interest rates still pose a dilemma for Australian investors, he says. “I think there will be one more rate cut; I can’t see a rate hike any time soon. So the return on term deposits is going to remain pretty low, around 2.5 per cent. That means that as an investor, you have to decide what you really want – do you want some income, but relatively low, as long as the capital value of your investment is unchanged; or do you want a higher, more stable income, but being willing to accept some volatility on your capital investment?
If you invest in shares, you can get a yield there of about 6.5 per cent–7 per cent, with franking, across the Australian share market. History tells you that the income flow from shares is actually more stable than the income flow from bank deposits. We’ve seen term deposits yields go from 7 per cent to 2.5 per cent in just a few years, whereas the dividends from companies tend not to move around that much. The only problem is that the underlying value of those companies moves around quite a bit. So it’s a trade-off,” says Oliver.
Oliver says he is often asked, “but what about Australian housing – isn’t it over-valued?” To which he agrees. “Australian housing has been over-valued since at least 2002. But a crash seems elusive.”
The main reason for the persistent over-valuation of Australian home prices relative to other countries is constrained supply, says Oliver. “Until recently Australia had a chronic under-supply of more than 100,000 dwellings. Completions are at record levels, but they are just catching up with the under-supply of prior years,” he says.
Secondly, Australia has not seen anything like the deterioration in lending standards that other countries saw prior to the GFC. “There has been no growth in so-called low doc and sub-prime loans, which were central to the US housing crisis. In fact in recent years there has been a decline in low-doc loans and a reduction in loans with high loan to valuation ratios. And much of the increase in debt has gone to older, wealthier Australians, who are better able to service their loans.”
Third, and related to this, there are no significant signs of mortgage stress. “Debt interest payments relative to income are low, thanks to low interest rates,” says Oliver.
James was founding editor of Shares magazine, and oversaw one of the most successful magazine launches in Australia. He has also written for BRW, Personal Investor, The Age and Management Today, and was subsequently personal investment editor at The Australian and editor of financial website, investorweb.com.au