Equities – what looks wild is really sweet
According to Senior Economist Diana Mousina, behind the current stock market turmoil lies a sweet spot for investing. This sweet spot however, will eventually come to an end – Diana shares the key signs to look for.
Behind the recent global stock market turmoil lies a sweet spot for investing, particularly outside of the US, according to AMP Capital Senior Economist Diana Mousina.
“Looking beyond short-term uncertainties, we remain in a sweet spot in the investment cycle, with equity valuations remaining okay (particularly outside the US), solid growth, improving profits, but still benign monetary conditions,” Mousina reported in the latest AMP Capital Investment Strategy report.
“We remain of the view that the broad trend in share markets remains up.”
US equities have just recovered from their worst week in two years and most global stock markets fell in response. On the back of that, inflationary pressures arising from improved economic conditions in the US could lead to an upward revision on the future path of interest rates.
While stock market volatility abounds, it’s for the ‘right’ reasons due to the likelihood that US borrowing costs will rise from a low base on the back of strong economic conditions, rather than due to fears of corporate losses, says Mousina.
The US Federal Reserve Bank raised rates three times in 2017 and has predicted a further three this year. AMP Capital expects there could be as many as five rate rises.
“The current combination of improving global growth and rising profits at the same time as low inflation and interest rates is very favourable for share markets, and explains why shares have continued to do well over the last year despite a seeming wall of worries around Trump, North Korea, elections in Europe, the Fed,” says Mousina. “This is commonly called the “sweet spot” in the cycle.”
Still, the market will be watching for signs that inflation is starting to rise in the US. To date, the signs have been mixed with better than expected employment and wage growth numbers causing the market slump in early February but other measures such as GDP growth coming in lower than expected.
“Expect a more volatile year as US inflation starts to stir,” she says.
When it does, the sweet spot may come to an end.
“While corrections are inevitable, the key signs to watch for an end to the sweet spot and increasing risk of a major bear market are: rapidly accelerating inflation pressures – with the US the main country to watch; high levels of capacity utilisation; excessive levels of spending or investment; excessive debt growth; and tight monetary policy,” she says.
The Eurozone may also face inflationary pressures, though less quickly than the US, according to Mousina. Core inflation is still below the European Central Bank’s 2 per cent target.
“Stronger growth in Europe will ultimately drive underlying inflation slowly higher, which should lead to a steady removal of accommodation, initially through an end to asset purchases, and eventually by moving interest rates higher,” she says.
In Japan, the economic data continues to improve but the tight labour market is yet to produce meaningful wage inflation.
In Australia growth remains mixed, with weak retail spending, a slow-down in housing but a strong labour market and stronger commodity prices.
“The Reserve Bank is in no rush to start hiking interest rates, and we see the first interest rate rise in December this year,” she says.