Outlook: David Bassanese

Any sharemarket setback caused by monetary tightening is likely to be temporary

After rising briskly earlier this year to almost reach the 6000 level in April, the S&P/ASX 200 index pulled back in May and June and the market faces several challenges – but also opportunities – over the nearer term.

In the main, the good news for investors is that the global economy continues to improve. At the same time, global inflation pressures remain contained.

That said, one important challenge for global equity markets over the coming months is a likely further rebound in still quite low global bond yields, which could put downward pressure on currently above-average price-toearnings valuations.

Indeed, despite stubbornly low global inflation, more central banks appear to be coming around to the view that monetary policy settings should nonetheless start to be normalised or risk letting equity market valuations reach dangerously high levels.

In the US, for example, the Federal Reserve has continued to indicate a desire to raise interest rates at least once more this year, and to begin to sell down the war chest of government bonds it bought up in recent years to inject further liquidity into financial markets.

While the Fed is unlikely to make any formal announcement with regard to its bond holdings – or change interest rates – in the next month, markets will remain on high alert for hints on the timing of further policy tightening later this year.

At the same time, the European Central Bank has also started to sound a bit more hawkish in recent weeks, as have central banks in Canada, the UK and New Zealand.

Our Reserve Bank is unlikely to join the hawkish bandwagon any time soon, given

interest rates in Australia are already somewhat higher than those evident globally. Instead, it is now hoping that higher interest rates elsewhere will help push down the Australian dollar to more competitive levels, which in turn could help breathe more life into our still sluggish economy.

Indeed, adding to the challenges faced by our own economy is the renewed downturn in iron ore prices in recent months – which is not great news for the resources sector. After strong gains through much of last year, iron ore prices have given back much of these gains in the face of Chinese efforts to rein in excessive steel-intensive property development.

Accordingly, a key issue to watch over the next month is the extent to which China continues to focus on economic “restructuring” – through policy restraint – or relents and allows a resurgence in property development and other steel-in- tensive infrastructure projects, if economic growth slows too quickly. So far, at least, renewed Chinese policy stimulus does not seem likely, as its economic indicators continue to suggest reasonably steady growth. On a brighter note, the second quarter US earnings reporting season could provide a timely boost to investors’ sentiment, particularly to the extent they remain nervous over the outlook for bond yields. After a flat period of earnings over 2015 to mid-2016, US earnings growth has since recovered and further solid growth is expected in the June quarter.

While the earlier rebound in oil prices is a major factor in the latest quarterly results (which has led to skyrocketing energy sector earnings), profit growth is also expected to be good in the key financial and technology sectors.

More broadly, global banks are one of the key sectors expected to benefit from rising bond yields (as it fattens net interest margins), while America’s technology giants continue to disrupt traditional business models across the world.

All up, while concerns over rising bond yields could lead to further consolidation in equity markets over the short run, the global growth backdrop remains positive enough to suggest such a setback could be only temporary.

That said, Australia’s growth challenges following the mining boom and rising global interest rates do suggest a growing focus on international investment opportunities, such as the global banking and technology sectors, which can be accessed via exchange traded funds available on the Australian sharemarket.