What’s in store for global equity markets

What’s in store for global equity markets?

Global markets felt the impact of political uncertainty in the June quarter. In Europe, the election of French president Emmanuel Macron and the strong performance of Angela Merkel’s Christian Democratic Union in German elections helped ease concerns of a spreading populist anti-globalisation movement, although rumblings continued in Ireland and Italy’s nationalist Five Star Party appears to be gaining popularity.

During the quarter, the MSCI Europe Index rose 7.4 per cent, supported by subsiding political risk, improved corporate earnings and a stronger economic backdrop.

The UK share market and currency initially responded well to calls by British Prime Minister Theresa May for an early snap election in the month of May to strengthen her leadership and kick start Brexit negotiations. But a hung parliament in June raised concerns about May’s future and saw UK share market fall 4.8 per cent in June, despite climbing 4.7 per cent in the quarter.

Brazil’s economic recovery also hit a road bump with the country’s long running political corruption scandal embroiling President Temer.

In Asia, North Korea’s nuclear missile program continued to cause tension although it’s not expected to affect equity markets as long as the US and China continue to cooperate on the matter. While the Chinese share market rose 6 per cent in the quarter, China is increasingly conscious of its financial fragility due to the country’s high corporate debt, complex wealth products and contentious shadow banking system. To overcome this, the People’s Bank of China and the country’s three key regulators (banking, insurance and securities) have united to address concerns about the opaque nature of the sector. Efforts, including the introduction of aggressive restrictions on permissible financial activities, are expected to defuse overleveraging and systematic financial risk in China’s economy over the long run but may have negative short-term repercussions.

In the United States, President Trump fuelled uncertainty about the US economy by controversially dismissing FBI Director James Comey, seemingly to halt an investigation into election fraud. This, alongside Congress’ inability to make meaning fiscal changes – demonstrated by its decision to push big infrastructure spending and tax reform out to 2018 – has led to dwindling support for the Trump administration. While the chance of a US stock market crash is minimal, US equities remained overvalued as at June 30, 2017 and face a potential correction.

As a result, ClearView has reduced its exposure to US shares in its model portfolios and increased allocations to Asia and Europe.

Outlook for Australian shares

Fortunately Australia hasn’t been affected by the global political uncertainty surrounding the Brexit fallout. However, questions about the direction of the Australian economy are emerging. The minor iron ore rally in the second half of calendar year 2016 helped push the domestic share market higher but iron ore prices have since come back due to growing stockpiles in China. Furthermore, domestic construction activity is beginning to slow.

Weak wage growth continues to be a concern, especially given the increasing cost of essential services like electricity and gas. This, combined with rising interest rates and tighter credit conditions, leaves Australians at risk of a credit and cash flow crunch.

Still Australia has an extremely resilient economy. It has recorded 103 consecutive quarters without a recession. Australia now holds the record for the longest run of uninterrupted growth in the developed world, according to the Australian Bureau of Statistics.  

The economy’s adjustment to the end of the mining boom in 2013 is largely attributable to a weaker Australian dollar which supports exports and tourism, and makes Australia a more attractive destination for foreign students. New South Wales and Victoria have picked up some slack by increasing investment in non-mining industries by 10 per cent annually while immigration has contributed to population growth.

That said, the Australian government and Reserve Bank of Australia appear to be running out of options to boost the economy. They managed to avoid the GFC by introducing various stimulus packages but these packages cost the government dearly and that burden is still evident. Further stimulus in the event of a downturn is unlikely. On top of that, taking the cash rate below 1.5 per cent will have minimal impact, evidenced by the impact in Europe which has had negative rates for some time.

While the Australian economy may be able to stave off a correction with continued immigration and expansion of non-mining industries, there are concerns it may be a case of delaying the inevitable.

Jessica Schlosser is an investment analyst at ClearView.