14 Feb Investors face a year of risks amid global uncertainty
The outlook for Australian shares is fraught with risks that could make for a volatile 2019.
From slowing global economic growth, contracting central bank balance sheets and rising interest rates in the US and Europe, to the US-China trade war, Brexit uncertainty and emerging markets debt jitters, investors globally face many challenges in the year ahead.
On top of a now synchronised global slowdown, the Australian economy has additional risks from tumbling house prices, risk-averse lending behaviour by the major banks and the prospect of a federal Labor government rolling back franking credits and negative gearing amid weak markets.
After almost meeting expectations for 2018 — the S&P/ASX 200 benchmark rose 5.1 per cent to a decade high of 6373.5 points by August — the local bourse is now down 7.6 per cent for the year to date.
It had fallen almost 13 per cent from the high to a two-year low of 5549.3 points, its biggest correction since 2016.
But while strategists are understandably cautious after sharp corrections in developed markets and sustained bear markets in emerging markets this year, they remain positive on Australian equities — albeit less so than before. Reasonable valuations, the prospect of sustained low interest rates from the Reserve Bank, share buybacks by companies, takeover potential (especially from cashed-up private equity), potential fiscal stimulus from Australia and China, and a now widely expected pause in US interest rate increases from the US Federal Reserve may still warrant a positive outlook.
“I think it will be up from now, but it’s a bit more of a guess as to the level in this environment,” AMP Capital head of investment strategy and chief economist Shane Oliver said.
Of four strategists’ forecasts for the benchmark S&P/ASX 200 index at the end of 2019 viewed by The Australian, the median was 6200 points, with a range of 6000-6500 points.
The median 12-month forecast for the S&P/ASX 200 was 11 per cent above Friday’s close at 5602 points.
Similarly, Bloomberg’s “best target price” — the aggregate of 12-month target prices for S&P/ASX 200 companies based on the “bottom-up” estimates of company analysts — was 6350 points.
But a rise in Australian shares of the magnitude projected by the consensus may be too optimistic.
Such a strong rise would make 2019 the best year since 2013, when the index rose 15 per cent.
However, the global economy is expected to slow for at least the next two years, with economists expecting weaker growth in the US, Europe, China and Australia, according to Bloomberg.
And despite a 90-day ceasefire in the US-China trade war that has seen significant US tariff increases delayed until March 2, the year is ending with no clarity on whether the global economy will stabilise in 2019, according to JPMorgan head of cross-asset strategy John Normand.
The S&P/ASX 200 is expected to open down 0.6 per cent at 5570 points today after the US S&P 500 index fell 1.9 per cent on Friday, following disappointing economic data from China and Europe.
Still, Australian shares are now entering what has often been the best two weeks of the year.
The decade-average rise in the S&P/ASX 200 in the final two weeks of the year is 2.8 per cent.
AMP Capital’s Dr Oliver said a better-than-expected Mid-year Economic and Fiscal Outlook today was “likely to enable the government to announce around $9 billion in income tax cuts and other pre-election goodies ahead of next May’s election and still maintain a surplus projection for 2019-20.
“The big risk, of course, is that the revenue windfall is not sustained as slower Chinese growth weighs on commodity prices, jobs growth slows and wages growth remains weak,” Dr Oliver added.
According to MST Marquee strategist Hasan Tevfik, the S&P/ASX 200 could rise to 6400 points, assuming a moderate improvement in its 12-month forward price-to-earnings multiple to 15 times and aggregate earnings per share growth at a slightly slower than average pace of 6 per cent.
Mr Tevfik said the S&P/ASX 200 was last week trading on a forward PE multiple of 14.4 times — near its long-term average — while the S&P 500 was also near its long-term average, at 15.1 times.
But Mr Tevfik conceded that “the chance of a material contraction in corporate profits in both the US and Australia is beginning to rise”. In other words, shares may not be as cheap as they appear.
“If so, this could be a point in the earnings cycle when 12-month forward ratios are less relevant and investors need to focus on longer-term valuation indicators,” he said.
Looking at cyclically adjusted PE (CAPE) or “through-the-cycle” valuations (derived from the average of company earnings per share over the past decade), Mr Tevfik said the Australian market was now trading on a CAPE of 17.3 times, almost 20 per cent below the average of this measure since 1980.
On the other hand, the US S&P 500 was trading on a CAPE of 30 times, which was 20 per cent above its average since 1980, suggesting Australian shares could be relatively better long-term value.
But Mr Tevfik said that was not by itself enough of a good indicator of short-term return potential.
To help determine the end of the current correction in shares, he is watching changes in the ratio of upgrades versus downgrades of earnings per share estimates by S&P/ASX 200 company analysts.
“History suggests that investors who are not interested in catching a falling knife should wait until the earnings revision ratio has shown clearer signs of turning,” he said.
“We stick to our positive outlook for Aussie equities, but concede the path higher is unlikely to start until there are clearer signs of the earnings revision weakness abating.”
Morgan Stanley strategists Chris Nicol and Daniel Blake have a more cautious target of 6000 points.
“While fairer value has been found, a cautious constitution is required as four flashpoints are navigated — spanning household deleveraging, banking conduct/regulation, China trade tensions/stimulus and elections/policy reform,” they said in a report this month.
“Downside risk” to consensus earnings estimates means “caution around multiples is warranted”, they said.
“In addition we see the S&P/ASX 200 as anchored by a tempered Morgan Stanley view for US equity markets and used as a funding source for greater upside in Asia/emerging markets,” the strategists said.
Morgan Stanley recommended clients hold underweight positions in banks and overweight positions in bulk commodity exporters such as BHP and Rio Tinto, as well as healthcare stocks such as CSL.
Citi strategist Tony Brennan — who trimmed his 2019 forecast from 6750 to 6500 points last month — said that with the overall valuation of the market now below its medium-term average at a time when earnings also are not high, “the return prospects could be the most promising in a few years”.
“The main concern is limited growth, but with profitability now more moderate in the larger sectors, the economy growing a bit above trend and likely to maintain close to that, and earnings estimates conservative, we see scope for reasonable earnings growth to underpin a resumed advance of the market, and can still see the S&P/ASX 200 at 6500 points next year,” Mr Brennan said.
As of Friday, the S&P/ASX 200 was down 7.6 per cent for the year to date — on track for its worst year since 2011, when it fell almost 15 per cent. It rose 7 per cent in each of the past two years.
A 6.1 per cent fall in October marked the worst October since the global financial crisis of 2008.
The index was also heading for its worst quarter since 2011 and its worst December quarter since 2008, with a fall of almost 10 per cent so far this quarter.