As we have been discussing in recent notes, it remains a challenging environment for investors. Valuations are stretched and there is a backdrop of heightened political, policy and macro risk that has not yet been factored into markets.
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Given developments in Canberra, here is a reminder of some of the main market implications from a Labor government.
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Over the past few weeks we have been highlighting the growing divergence between stock market performance and accumulating macro and political risks. The growing list of risks include the potential trade war, weakening Chinese growth and funding pressures in emerging markets.
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An important role for tactical asset allocation is protecting portfolios against discrete market-moving events that are hard to predict. A US/China trade war is now shaping as a binary event and the impact on markets could be large because investors appear to be assuming that there will not be an escalation.
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We recently reduced our recommendation for global equities to neutral reflecting rising risks around the political, macro and policy environment. We see this as a tactical change and have not changed our medium-term view that equity markets will continue to deliver good returns over the next 3-5 years.
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China is entering a new phase of reform with a key focus on improving financial stability and reducing government debt. Measures that have already been announced include banning state-owned banks from lending to local governments and the cancellation of some major projects.
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The past few years have seen the best combination of factors for markets: improving economies, easy policy settings, low inflation and strong earnings. However, the major improvement in global growth may now be over and synchronised recovery may now give way to a more diverse range of outcomes.
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We review how February’s market volatility has affected valuations across the asset classes. Equity valuations have improved significantly; credit has been surprisingly resilient; bond yields have moved closer to normal but have some scope further to fall; and the $A has moved closer to our fair value estimates.
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We expect major changes in monetary policy this year across the globe, including from the RBA. We now assume two raise rates in Australia in 2018. Markets are not fully positioned for hikes in Australia and Europe. These expectations are more aggressive than what is currently priced into markets.
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During 2017 the stars aligned with rising GDP and earnings, falling inflation and easy monetary policy. These effects will carry into 2018 but they will fade. The critical factors will be the pace of reform in China and whether inflation returns as an issue for central banks.
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