Interest rate differentials between the US and Australia are set to narrow further, creating Foreign Exchange opportunities for investors
In our December update, Nick Ryder, NAB Private Wealth Investment Strategist, highlights how equity markets rose again in November helped by expectations of further monetary stimulus from the European Central Bank.
Although interest rates in the United States are likely to be increased this month, and to gradually rise to historically more standard levels over the next few years, we expect that equities will continue to be the most attractive asset class over the medium term.
In Australia, the weighted average dividend yield of 5.1% plus franking credits represents an attractive premium over government bond yields which are less than 3%. These yields should provide support for the local share market in any pull back. If earnings grow by 5%, as expected in the year ahead, then the total return from local equities is reasonably attractive, all else being equal. Our preference is for mid –sized companies with structural growth in industries not suffering from commoditisation and over-capacity.
Internationally, we continue to favour Europe, Japan and Asia over the United States, which remains more expensive.
Although we remain underweight in fixed income, we prefer floating rate corporate bonds and are beginning to see value in international credit, which has underperformed this year, but should provide attractive returns going forward.
ECB stimulates further – As expected, to combat low inflation, the European Central Bank cut interest rates on excess bank reserves from -0.2% to -0.3% per annum and extended its €60 billion per month asset purchase program by six months to March 2017.
Equity markets rose in November, helped by expectations of further monetary stimulus from the European Central Bank. Other changes included:
In the United States, employment growth continues to be relatively strong with an average 210,000 jobs created each month in 2015. This has pushed the unemployment rate down to 5% from 5.8% a year ago. Although employment growth has been strong, wages growth has only recently begun to trend higher with average hourly earnings about 2.3% higher that year ago levels pointing to possible inflation pressures down the track. Although business conditions have weakened recently, in part due to the stronger US Dollar and issues in the oil and gas sector, it looks likely that the Federal Reserve will begin the process of normalising interest rates this month.
In Europe, the unemployment rate has fallen again last month from 10.8% to 10.7% and economic growth has been reasonable at around 1.7% year-on-year – which is not bad by European standards. In early December the European Central Bank cut interest rates and extended its asset purchase program by six months to try to boost inflation and weaken the Euro. However, investors were left disappointed that the stimulus measures didn’t go further.
In China, the trend slowdown in the manufacturing and export sector continues but other parts of the economy, aimed at the provision of services and retail sales to consumers, continue to improve. As expected, the International Monetary Fund announced that the Chinese Yuan would be given reserve currency status, which although largely a symbolic move, could lead to further relaxation on capital controls and government intervention in capital markets over the next 12 months.
The Australian economy continues to make progress in the slow transition from mining investment, to growth in the non-mining parts of the economy. The most recent GDP growth figures for the September quarter were stronger than expected with annual growth recovering from 2.0% to 2.5%, helped by a lift in net export growth. Although the falling commodity prices will hamper exports in the coming quarters, other indicators such as business lending, business conditions, retail spending and employment growth all point to solid economic growth over the next two to three years. The local economy continues to be supported by the tailwinds of low interest rates, lower energy prices and a weaker currency.
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