Reasons Sharemarkets Are Charging Higher
Expectations of a slowdown – even a recession – in the global economy have been widespread in recent months. As a result, bond yields have fallen over the year to date, causing bond prices to surge.
However, most sharemarkets have continued tracking higher, with US and Australian shares having delivered returns, including dividends, since the start of the year of more than 20 per cent.
Here are pointers on why average returns to share investors in the US and Australia have been buoyant.
- At the start of the year, investors held exaggerated prospects of the Fed soon raising the US cash and choking the US economic upswing; and shares were seriously oversold. In February, the prevailing view changed to the US cash rate being left unchanged. Since May, widespread predictions for cuts in the US cash rate have periodically enhanced the appeal of shares in the US and in other countries.
- The US and Australia differ widely in economic structure, the types of listed companies that dominate share trading, and politics.Nonetheless, our sharemarket usually takes its direction from moves in US shares – and that relationship has remained strong this year.
- In earlier decades, swings in average share prices in Australia were generally larger, in percentage terms, than the moves in US shares. By contrast, in the last 12 months, the ups and downs in our sharemarket have often been smaller than those in US shares. That is because: our economy is seen as more stable than it used to be; our major export, iron ore, has enjoyed buoyant prices; and we don’t have the big technology stocks that occasionally cause big wobbles in US shares.
- With prospective price-earnings multiples around 18.5 times in the US and 16.5 here, average share valuations are above average though not as stretched as in many earlier bull markets.The good news is the US is unlikely to experience an early recession; but with the recent reporting seasons in both countries somewhat soft, there will be times when many investors feel current valuations are uncomfortably high.
- Interest rates on cash, term deposits and bonds are still at exceptionally low levels, due to mild inflation and expectations that central banks will ease further. The “hunt for yield” still provides an incentive for investors around the world to seek shares paying good (and reliable) dividends.
- Given our system of franking credits, dividends have additional appeal to Australians. Of course, investors need to avoid “dividend traps” (where a high dividend yield reflects the drop in the share price caused by a well- based expectation that the dividend will soon be cut).
- Currently, the biggest risk for share investors is a weakening in global economic conditions if the trade and technology tensions between the US and China worsen. Investors should expect some further swings in market sentiment, and hold some cash for opportunistic purchases of shares.
- If the recent sell-off of US bonds were to resume, shares could lose some lustre for a time. Usually, sentiment in sharemarkets turns negative for a time whenever bond yields spike – before it becomes clear that the important thing is what’s caused the rise in bond yields.
- With bond yields low, prospects of bond investors enjoying further capital gains appear limited or non-existent.
At times, bonds will be said to be riskier than shares; but investors need to be aware of the benefits and risks of both major asset classes.
- The outlook for shares contains quite a few uncertainties and many shades of grey. In my thinking, the main worry for share investors in the next year or two would be an escalation of the trade and technology wars.
We should also expect occasional market dips, which would provide patient and longer-term investors with opportunity to pick up quality shares, such as CSL and Microsoft, at attractive prices.
Don Stammer is an adviser to Stanford Brown Financial Advisers. The views expressed are his alone.