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Investment commentary August 2016

Quick overview

  • Share markets and growth assets generally had a strong recovery in July
  • Recent economic data has been mixed, and politics has been volatile
  • In the current environment investors are prioritising income, and this can mean that weak economic data sees positive returns from growth assets
  • This relationship is probably not permanent, but it might be a feature of financial markets for some time yet

Uncertain times

We do live in an unusual world at the moment. Uncertainty about the economic outlook has been increasing, with incoming data conveying mixed messages on the strength of the global economy. Political wild cards have also been a feature lately. Brexit, Trump and – for weeks following the federal election – the potential for a hung parliament in Australia.

Bad news is good news

After a brief fall following the UK referendum vote, share markets have powered higher in July, up over 6% in Australia and 4% globally. The reason for the rally? Partly due to the relief that Brexit didn’t spark a global crisis. But it’s also indicative of an ongoing trend.

While investors would normally cheer the positive impact on company earnings from good economic news, these days they’re more focused on income.

It seems, in the current climate as far as the share market is concerned, that “bad news is good news”. While investors would normally cheer the positive impact on company earnings from good economic news, these days they’re more focused on income. The weaker the economic outlook, the more likely we are to see central banks continue with policies to stimulate economic growth by lowering short-term interest rates.

Very low interest rates is not always a good thing

With interest rates around the globe already at extremely low levels, investors are being forced to look elsewhere to generate the income they need. So they end up competing with each other to drive up the prices of assets. Bad economic news means interest rates will probably stay lower for longer, so shares, credit and real estate look more attractive on a relative basis.

Of course this can’t go on forever, and the relationship is unlikely to hold at extremes. If the news gets bad enough then concern about the impact on company profits will overwhelm the desire to chase yield. We could then expect to see share prices fall and credit investments come under stress.

Conversely, at some point, good economic news will be seen as a positive and shares will be sought after for their ability to participate in growth. It’s hard to predict the point where good news becomes good news again, but we suspect it will probably not happen until interest rates start to move higher and investors looking for safety in cash are able to earn a better return.


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