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What’s the outlook for Aussie equities?


The Australian share market has experienced a period of significant volatility recently.

 

According to investment research portal Trading Economics, the S&P/ASX 200 stock market index has traded in a range between 4,706.70 points and 5,826.50 points over the last 12 months (as at 4 May).

According to Trading Economics’ global macro models and analyst expectations, it expects the S&P/ASX200 index will be at 4670.00 in 12 months’ time. Its view of the performance of the index in the short-term is, however, slightly more rosy. It expects the index to be at 5090 points by the end of the quarter.

So what are the variables that are likely to impact the share market in the short- to medium-term?

1. The direction of local interest rates

In May the Reserve Bank of Australia lowered the cash rate to an unprecedented 1.75 per cent, which had an immediate and positive effect on the local share market. Any further interest rate cuts would also be positive for the local share market. This is because when rates drop, it makes investing in cash less attractive and investing in equities relatively more attractive.

However the gains the market experienced subsequent to the cash rate announcement were quickly reversed as investors digested news from this year’s federal budget. Concessional caps were reduced from $30,000 and $35,000 to $25,000 and from 1 July 2017 a $1.6 million cap will be introduced on the amount individuals can contribute to a private pension fund.

This may potentially reduce fund flows into equity markets and dampen share market performance. However, the impact won’t be known for some time.

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2. The direction of US interest rates

Another major influence on the local share market is the US’s approach to its cash rate. It lowered the official interest rate in December 2015 for the first time in 10 years to between 0.25 per cent and 0.5 per cent.

This also had a positive effect on both local and global shares initially. While the US Federal Reserve has not acted this year to lift rates, its rhetoric suggests it is open to further rate cuts down the track. This would also be positive for the local and US bourses.

3. The value of the Australian dollar

Another major variable that affects the share market is the local currency. The value of the Australian dollar has declined substantially since it reached $1.09 against the US dollar in 2011. It has traded in a range between 68 cents and 77 cents against the US dollar since the start of the year and is now trading at about 74 cents, having fallen from about 77 cents after the interest rate announcement.

Any drop in interest rates usually causes a decline in the currency. This is positive for exporters as it makes their goods more competitive on global markets. But it’s not so positive for importers as it makes their inputs relatively move expensive.

4. The transition to a services-led economy

Another influence on the performance of the local share market is the switch from a mining investment-led economy to one that is services-led.

So far this process has been relatively smooth, and it is expected this will continue. The net effect on the local share market is that mining and resources stocks are likely to remain subdued, while the performance of service sector businesses should improve.

5. The China factor

Another important influence on the local share market is the performance of Chinese equities. Earlier this year intense volatility on the Shanghai exchange led to a drop in the value of the local market. This was unprecedented given only a few years ago the Chinese stock market had little bearing on the local market, which took its lead from the US market.

This dynamic seems to have shifted and it now appears the global share market takes its lead from China, although signals from the US market are also important.

This is really the unknown factor in the local economy. So while interest rates and also economic performance will continue to be the major factors that will drive the Australian share market, the greatest unknown factor is the influence the performance of overseas markets will have on local equities.

Shares are a high risk/high return investment. Self-managed super fund investors should remain abreast of developments in financial markets, but always maintain a focus on long-term investment goals, rather than short-term market movements, when taking decisions to invest.

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