Spotlight on the sharemarket

The heightened risks surrounding the Australian economy continue in light of the transition away from mining-related investment and an over-reliance on the residential property sector for growth. In fact, Australian companies are continuing to experience relatively soft trading conditions. Earnings growth has only accounted for around 10 per cent of share price returns since 2012 with the remaining 90 per cent due to valuation increases. Average dividend payout ratios are also at historical highs.

Despite limited improvement in underlying company fundamentals, the recent interest rate cut highlights the continuing challenges faced by the Australian economy and has provided (and may continue to do so) ongoing support for valuations. The cut actually appears to be the result of a more ‘risk-on’ investment environment in light of rebounding commodity prices and continued monetary stimulus compressing yields for investors. But the commodities rally is not likely to be sustainable given oversupply issues are yet to be resolved.

So when it comes to shares, in the absence of material earnings growth, the S&P/ASX 200 is currently trading at valuation levels well above long-term averages. While Australian shares are not in so-called ‘bubble territory’, those current  levels do place significant headwinds on prospective returns for the asset class, particularly in absence of any earnings growth.

As investors adjust allocations to higher risk assets, the recent cash rate cut may provide support to domestic asset prices as will any changes to monetary policy or fiscal stimulus. This should be considered in any assessment of allocations towards equity markets, but any further decreases to the cash rate target would broadly suggest a worsening of underlying economic conditions, meaning an increase in headwinds to the outlook for locally domiciled companies.

Considering Australian equities through diversified, liquid and low cost investment vehicles, such as properly structured Exchange-Traded Funds and well-run Listed Investment Companies is advisable. In fact, now is an opportune time to consider taking advantage of recent market strength to rebalance your portfolios if you have an overweight exposure to the asset class. But please exercise caution with regard Australian equities and the domestic banking sector and seek personal financial advice.

This insight may contain general financial advice and was prepared without taking into account your objectives, financial situation or needs. Before acting on any advice, you should consider whether the advice is appropriate to you. Seeking professional personal advice is always highly recommended. Any forward looking statements are based on current expectations at the time of writing. No assurance can be given that such expectations will prove to be correct.

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Patrick Broughton

Investment Committee Member

Patrick has 32 years of investment banking experience spanning over a broad range of financial markets, including equities, fixed income, hybrids and convertibles and foreign exchange.

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