As the dust settles on the latest reporting season, it is timely to consider the outlook for Australian equities for the remainder of calendar year 2016.
Some factors that we believe will play out in the market over the short term include:
US interest rates to weigh on markets
The immediate focus for equity markets globally is the outlook for US official interest rates, which we believe will continue to cause short-term volatility in the overall direction of the market. Following the US Federal Reserve’s rate hike last December (its first since 2006), talk of a further rate rise earlier this year saw equity markets fall dramatically. Again this week, markets reacted strongly to suggestions an imminent rate rise could be on the cards.
By maintaining interest rates at historically low levels, the central bank did a good job of ensuring the US economy recovered following its deep recession of 2008 and 2009. However, as the economy strengthens, it is now apparent interest rates are set to rise over the next five to ten years. Although the US Federal Reserve has demonstrated it will implement increases slowly and methodically, we expect the tightening cycle will weigh on US shares as equity markets traditionally tend to struggle as interest rates rise. As always, we will be monitoring bond markets very closely in the coming months.
Australian rate rise on the cards
Following last week’s better-than-expected GDP figures, we believe any further rate cuts from the Reserve Bank of Australia are now unlikely. We will be able to form a firmer view following the release of further economic data, particularly the next inflation figure due out in October. If the inflation imprint provides additional evidence that the economy is improving, then Australia’s loosening rates cycle may well be over.
Pre-Christmas IPO rush
Between now and Christmas, we are expecting an increase in corporate activity with our sources reporting that a number of companies are preparing to list or undertake secondary capital raisings to finance mergers and acquisitions. Given that we are now in the mature stages of a bull market, in our view the quality of companies coming to market via initial public offering is starting to deteriorate.
Cautious on Chinese consumer stocks
We believe a number of companies leveraged to the Chinese consumer are set to experience volatility as China’s regulatory changes to foreign imports start to impact their bottom lines. This effect was evidenced in the recent results announcement from Blackmores, which is heavily invested in the Chinese market, foreshadowing a lower first quarter result. Other companies with businesses which may be exposed to the regulatory risk include The a2 Milk Company (ASX: A2M), Bellamy’s Australia (ASX: BAL) and BWX Limited (ASX: BWX). The inventory balances at 30 June 2016 for some of these companies also provide warning bells for us.
AGM comments key
Given many companies provided guarded outlook statements and were cautious in their profit guidance during the recent reporting season, our focus is now on their upcoming annual general meetings (AGM). The AGM season will be critical to assessing the outlook for each business and we will be paying particular attention to companies’ forward looking commentary. With the protracted federal election campaign having a dampening effect on the economy we will be looking for evidence of improved trading conditions following the poll on 2 July this year.
Currently trading on an average price to earnings (P/E) ratio of 15 to 16 times, which is slightly above the long term average, the market is quite fairly priced in our view. Following reporting season, we are not currently confident that the market will move significantly higher in the short term. Many companies remain focused on cost-outs and are still struggling to achieve revenue growth. Mining services companies are a notable exception to this trend with businesses in the sector starting to see an improvement in revenue growth. Looking further ahead, over the next one to two years company earnings per share (EPS) growth will be required to drive equity prices significantly higher.
Overall, we are cautious in our outlook for the equity market although we are continuing to find investment opportunities and anticipate we will continue to do so. Rather than being sector-specific, these opportunities are found amongst companies that are achieving growth.