How do higher bond yields actually affect sharemarkets?
The Australian sharemarket finished the 2017/18 financial year with a solid gain of 13%.
A favourable global macro-economic backdrop provided the tailwind for this result, in particular:
• Our inflation remains benign at 1.9%.
• Our unemployment is steady at 5.4%.
• Australia’s GDP growth rate of 3.1% is solid.
• The Australian economy and Australian companies have benefitted from improving global economic growth.
• A lower Australian dollar has been supportive for tourism and education-related companies along with exporters, and increased interest from offshore corporates looking at acquiring Australian companies.
• Interest rates in Australia remain low, and are unlikely to move meaningfully higher in the next 12 months.
These tailwinds should continue for some time, however there are also potential headwinds going forward for the Australian sharemarket. For example:
• Economic growth in advanced economies is expected to slow slightly in 2019.
• The persistence by US President Trump in pursuing tariff protections against a variety of trading partners has increased the risk of a trade war undermining global trade and, in turn, global economic growth. If the current posturing does result in a trade war the Australian economy is vulnerable as China is Australia’s most significant trading partner and a major target of proposed tariffs by the United States.
• A possible slow-down in Chinese economic growth (irrespective of a potential trade war with the US) could negatively impact demand for our commodities and consequently commodity prices.
• The regulatory response to the Royal Commission into Financial Services has the potential to change the landscape for some businesses as does the slow-down in the housing sector.
Two Australian sharemarket sectors have defied the upward trend
The Australian sharemarket, despite posting another solid financial year’s performance, has provided challenges to investors as market leadership continues to evolve. Market sectors such as Financials and Telecommunications, which have been excellent performers for the past 10 years, have been out of favour with investors over the past six months.
The Telecommunications sector – driven predominantly by Telstra – was down 23.2% for the first 6 months of 2018.
The Financials sector – accounting for nearly one-third of the S&P/ASX 200 – was down 2.1% for the first 6 months of 2018.
On the other hand, Healthcare was a standout sector for the first half of 2018, posting a return of 24.5%. Materials (+8.1%), Consumer Staples (+12.3%) and Energy (+11.8%) were amongst the other strongest performing sectors for the half year to June 2018.
In the medium to longer term the Australian sharemarket should continue to provide healthy returns for investors. Notwithstanding the challenges of a housing slowdown, changing market leadership and geo-political uncertainties, the environment is conducive to growing earnings. However, it is probable that returns over the next five years are unlikely to match the 10% p.a. achieved over the past five years as the prospect of rising interest rates, a housing slow down and potential trade war serve to temper growth in the future.
By Tim Schroeders, Investment Research Department – Australian Unity Personal Financial Services.
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