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What’s in store for the ASX?


What is likely to drive the market for the rest of 2016?

 

The S&P/ASX 200 started the year at 5319 points, traded down to 4765 in February and is now at about 5400 points. This indicates how volatile the share market has been this year. So what’s likely to drive the market for the rest of the year?

One of the drivers of share market performance since May has been the Reserve Bank of Australia’s (RBA’s) decision to cut the cash rate to 1.75 per cent. This has had a positive impact on the market.

The rate cut has eased pressure on company earnings, particularly for banks and buoyed sectors such as real estate investment trusts (REITS). It also appears that the rate cut was the prime reason behind the positive impact on recent consumer confidence score. The Westpac Consumer Confidence Index surged to 103.2 points in May. Any score above 100 indicates the number of optimists in the survey sample outweighs the number of pessimists.

AMP Capital’s view is that there will be at least one more rate cut this year and potentially two cuts if the Chinese economy falters. Any further cuts should ease the cyclical pressure on earnings and help to reverse the recent strength of the Australian dollar. A decision by the US Federal Reserve to raise its official interest rates will likely lead to a lower Australian dollar, which is good news for the share market as this makes our exports more competitive overseas.

Sectors to watch

In terms of sectors that could produce outperformance, mining and resources could experience short-term upgrades, versus long-term supply and demand issues.

But within the industrial sector, price-to-earnings ratios are elevated, so it’s best to pick the most defensive stocks in the sector, or those with a high level of balance sheet flexibility.

As for sectors likely to experience soft trading conditions, banks are expected to have earnings downgrades and dividends may be trimmed. Conversely, relative valuations look attractive. As the RBA looks poised to cut the cash rate again, bank stocks are likely to trade in line with investor sentiment on the local and region outlook.

Investors should carefully consider exposures to the retail sector. Additionally, it’s worth keeping in mind that REITs and unlisted shopping centre cap rates are at or near record lows.

Market drivers

Some of the trends that have been so prevalent in recent years, for instance share market momentum, earnings revisions and growth have been disappointing so far in 2016. Earnings revisions in particular continue to trend downwards across all sectors, although the materials and energy sectors have experienced some improvement from low levels. This is a risk, particularly as markets look expensive in absolute terms and overbought in the short term.

One relative bright spot is small caps, which continue to outperform large caps, seeing better earnings revisions and higher growth levels.

Many local investors are positioned for yield. But it’s important to be selective when choosing stocks for yield as almost 20 per cent of ASX 200 companies have cut dividends in the past year and payout ratios are at elevated levels.

There is only one sustainable way for companies to create capacity to return cash to shareholders and grow capital base and therefore additional value: they must generate returns on capital above their cost of capital. So long-term, yield-focused investors need to concentrate on identifying quality companies in which to invest.

One of the most important questions for domestic investors is to what degree Australia can rebalance its economy through tourism, education and healthcare as the commodity and housing booms have passed their peak.

This question should be at the forefront of SMSF investors’ minds as they select investments for their portfolio.

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