Is it time to be rationally optimistic?

Report

Martin Lakos, Division Director, Macquarie Private Wealth
Thursday 01 December 2016

Over many economic cycles, the stock market has been a reliable leading indicator of confidence and appetite for risk.

The share market's main index, the ASX 200, has just touched a seven-year high having rallied about 750 points since mid-December 2014, a gain of around 14.5%.

Typically the share market leads by six months, so could we expect an improvement in business conditions and consumer spending?

Certainly investors are voting with their hard-earned funds, redeploying cash from low interest bank deposits.

Share markets rise – and fall – based on a number of factors, including sustainable company profits and dividends, interest rates, the currency, liquidity and importantly the global economic outlook.

Share prices had rallied in anticipation of the official cash rate cut announced by the Reserve Bank of Australia (RBA) in February to 2.25%. Demand for higher investment returns by investors and retirees seeking sustainable income from dividends are also factors.

It is Macquarie's view that the RBA will cut official interest rates again in the coming months, taking the official cash rate to 2%. This may put further pressure on deposit rates, but will also curb interest costs to businesses and consumers.

Also, we can't ignore the fact that ASX-listed companies have generally been reporting profits and dividends in line or better than expected. This is the third consecutive half year reporting season that has beaten analyst forecasts, albeit modestly.

So, why the large gap between investor confidence and that of business and consumer confidence?

I believe we need to differentiate between short-term influences and longer-term factors, rather than rely on stock market performance alone as a forward indicator.

The Westpac Melbourne Institute Consumer Confidence Index, released in late February, was up 8%, its highest level since January 2014.

The NAB Monthly Business Survey for February showed business conditions unchanged but a broad-based fall in confidence was recorded, (manufacturing and wholesale reported a rise) despite the RBA's interest rate cut in February.

What will it take for the real economy to reflect the share market's optimism?

A combination of factors may turn sentiment up. These include sustainably lower interest rates, which will ultimately get traction over time (as we've seen in the US) and potentially a moderate, sensible budget in May that will begin to address the deficit issues.

A combination of factors may turn sentiment up. These include sustainably lower interest rates, which will ultimately get traction over time (as we've seen in the US) and potentially a moderate, sensible budget in May that will begin to address the deficit issues.
Martin Lakos

The Housing Industry Association (HIA) is forecasting that 195,000 new dwellings will be built in the new financial year (a 7.7% increase) and this aligns with the latest housing approvals data – which is at a cyclical high.

If history is anything to go on, the rising stock market is calling for a little rational optimism.

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