Market Update – December/January
Global outlook
As we move in to the new year, there are three main factors affecting global markets:
- US economic recovery
- continuing sovereign debt issues in Europe, and
- threat of inflation in Asian countries, particularly China.
From a global equity market point of view, encouraging signs remain despite the risks. After a couple of years of effective rationalisation, corporate America now looks in good shape, with strong corporate balance sheets and very high levels of cash flow generation. Thus far however, corporates have been relatively cautious in terms of putting their cash to use. With highly supportive monetary conditions and a US government whose main priority leading up to the 2012 election will be job creation, conditions are well-suited for increased corporate activity and more aggressive growth strategies, particularly as valuation levels are not onerous.
The clear risk to domestic equities is that higher inflation in China persists which may lead authorities to curtail credit growth more aggressively. The resulting softening in the property market would see softer demand for commodities with clear implications for the resource sector. Australia continues to be characterised by the ‘two speed economy’ with higher interest rates proving a strong headwind for the consumer based domestic economy and continuing strong activity in the resource related sectors. However, we believe that there will continue to be investment opportunities in companies across the breadth of the market, particularly as valuations are quite supportive.
On the debt side of the ledger, clearly sovereign risk remains a key concern. Many of the serious problems that came out of the GFC have not been solved but merely patched up. Perhaps the most serious of these are in Europe where the overall level of debt remains too high. So far attempts to resolve these sovereign issues have sometimes illustrated the political tensions and different agendas that are evident within the Eurozone members. If these issues are dealt with poorly there is the risk of contagion to the broader financial sector. Globally, sovereign debt levels are high and yields are low. The spread between the equity earnings yield and bond yields are also stretched. Therefore a continued economic recovery may well push government yields higher.
