Hold your nerve in time of global uncertainty
Investors have good reason to feel uncertain about the prospects for both the Australian and world economies. While our large mining companies are expressing confidence about the future of commodity prices, the share market responded unfavourably to announcements of reforms in the Chinese economy.
Last week, meanwhile, markets were concerned about the tapering of quantitative easing in the US, while this week US markets reached a record high on the basis that tapering would not occur for some time yet. In Europe also, the European Central Bank has reduced its short-term official interest rate while Britain and Germany are reporting stronger economies.
Against this generally confused background, further movements in the world economy and share markets are a puzzle but, on the whole, the strong performances of share markets over the past 18 months suggests further if only modest improvements in the world economy.
There are no indications interest rates in Australia and around the world will rise dramatically. The concern about the impact of the tapering off of US quantitative easing is that this will result in higher interest rates in that country and lead to a repatriation of US overseas investments. This could lead to increased funding costs for our banking system, but it is also possible inflows of capital from Asia and even Europe could replace the lost US inflows.
Apart from the desire to stimulate the domestic economy, the objective of continuing low interest rates and quantitative easing in Japan and Europe is to depress the exchange rate and improve competitiveness. Indeed, this appears to be the reason for the latest reduction in the official European interest rate despite opposition by Germany and Austria. The objective was to weaken the euro,which had been reaching recent highs against the US dollar.
The continuing strength of the Australian dollar is understandable in this context. The Reserve Bank is trying to talk the value of the dollar down as it is no longer able to reduce our official interest rate because of the emerging property boom and the expanding federal budget deficit. The message for share investors is to be prepared for volatility while interest rates continue to boost the demand for shares.
To be able to hold their nerve if markets gyrate, however, investors need to be able to live with volatility and not be forced to sell out when markets are depressed. While a 20 per cent increase in our share market to the previous record high does not look likely, brokers generally are confident a further rise of 10 per cent is possible. That would result in price earnings ratios higher than previous historical averages but interest rates at still near record lows.