Since the global financial crisis (GFC), equity markets have been particularly affected by macro-economic factors. Identifying and understanding Australian and international macro-economic drivers is therefore a crucial element of investing given their potential to impact company earnings, and ultimately the performance of an investor’s portfolio.
Three key macro-economic themes we are currently focused on are: the approach taken by central banks globally to monetary policy, the state of the Australian consumer and the outlook for China.
Central bank policy
Following the GFC, central bankers took unprecedented steps to support their economies, slashing official interest rates to record lows and injecting extraordinary levels of liquidity. Since 2008, the world’s 50 largest central banks cut interest rates 700 times and injected $9 trillion of liquidity into markets worldwide. Key for equity markets and investors alike will be the central banks’ approach to unwinding the unprecedented monetary and quantitative easing measures adopted over the last decade, including massive bond-buying programs.
Various central banks, including the US Federal Reserve and the Bank of Canada, have recently commenced unwinding these measures, raising rates and withdrawing liquidity as conditions strengthened. With the exception of Japan, other nations are set to follow suit, signaling they too will raise rates and reduce the size of their balance sheets.
The shift in the central banks’ policy approach reflects the strengthening global economic environment as the consequences of the GFC continue to recede and marks the end of easy money. It is critical that central bankers do not take an aggressive stance on this transition, and instead adjust policy settings to appropriately reflect improvements in economic conditions. In our view, as stimulus is withdrawn, draining liquidity from markets, the main issue for investors to consider will be whether company earnings growth, coupled with economic growth, will be sufficient to offset this reduction in liquidity.
Australian consumers’ financial position has consequences for the broader economy, as well as a range of particular sectors and companies. In the short-term, out-of-cycle interest rate increases by the banks, together with rising power prices and insurance premiums, have had a dampening effect on consumer sentiment and reduced total discretionary income. Although the fiscal health of the Australian consumer remains fragile, global economic growth, increases in full-time jobs and low unemployment provide a positive outlook for consumers.
Expectations of wage rises, rather than actual wage growth, will be key to boosting confidence and increasing spending. Currently, expectations of future income growth are low due to benign wage growth for an extended period. Lower expectations of earnings growth can lead to lower levels of consumption.
Some companies, such as supermarkets, stand to benefit from these headwinds with the consumer staples segment of the retail sector largely unaffected by a reduction in discretionary spending and offering investors a defensive ‘play’.
As Australia’s largest trading partner and the world’s second largest economy, China is critical to the Australian economy and the financial viability of many ASX-listed companies. In our view, the outlook for the Chinese economy is overall positive. The economic performance of the Middle Kingdom continues to exceed expectations with fears of a sustained slow-down following the withdrawal of stimulus measures in 2015 proving to be unfounded.
Continued industry reforms, including to state-owned enterprises (SOE), to create a strong private sector will be important to China’s continued economic strength and increasing the economy’s long term productivity. With SOEs absorbing significant national capital and delivering low returns, the Chinese government is progressively implementing policy changes to restructure and modernise the sector, including improving governance practices.
The Communist Party of China’s upcoming 19th National Congress will also be instrumental to the nation’s economic outlook. Held every five years, the gathering will determine China’s political future including the leadership and economic policy agenda. If President Xi Jinping tightens his grip on power, the potential to enact various reforms to the economy will increase. Ahead of the Congress, the political environment is generally risk-averse with officials up for re-election keen to ensure current growth levels are maintained and shying away from major reforms that could dent current growth levels.
In our view, the overall outlook for the Australian and global economy is positive. A range of macro factors will continue to shape the operating environment for Australian listed companies and influence their share prices. Investors should continually consider and monitor big picture economic issues and trends, giving consideration to how they may impact the Australian and global economy, the share market and individual companies within their portfolios.