End of Financial Year Review
This financial year has proved to be another up and down one for the Australian share market, albeit with smaller swings than we have had at times since the global financial crisis.
After touching a high of 5,707 points on 21 July 2015, the S&P/ASX 200 pulled back to 4,765 points on 12 February 2016, in part due to weakness in miners and energy stocks as well as an adverse shift in sentiment towards the banks. A recovery from this low point was then halted by the UK Referendum (BREXIT) in late June.
The UK voted to leave the EU with a resultant shock to financial markets globally, which beforehand had moved significantly towards a “remain” outcome. The initial decline in global financial markets over the days after BREXIT reflected elevated uncertainty and therefore heightened volatility.
The index finished the fiscal year 2016 at 5,233 points, down 4.1%. Nevertheless, the Utilities and Property sectors were the standouts, rallying 18% and 19% respectively, reflecting the decline in interest rates. The 10-year Australian Government bond yield has declined from 3.01% to a record low of 1.98% over the past 12-months. On the other hand, the Energy sector fell 25%, Financials (excluding REITs) declined 14%, and Materials shed 8%.
Commodity prices continued to remain subdued for most of fiscal 2016 reflecting softening growth in China and continuing growth in supply. Brent oil closed the financial year at US$50 per barrel and iron ore closed at US$56 per tonne, which were lower than their close of US$68 per barrel and US$59 per tonne respectively in June 2015.
In regards to BREXIT, there are going to be adverse impacts across Europe and, to a much lesser extent, the world at both economic and political levels as the UK and the Eurozone account for only 6% and 28% respectively of global GDP. In response to BREXIT, the various central banks are likely to provide even further monetary policy support, albeit they have much less scope to act than usual in this post GFC environment. The European Central Bank could lower interest rates yet again and the US Federal Reserve could delay any further lifts in interest rates.
In Australia, we expect some limited adverse impact on the economy and the outlook for commodities, except gold. The Reserve Bank is now much more likely to reduce the official cash rate to 1.5% over the coming months.
The Australian dollar has fallen around 3% over the year from around US77 cents at June 2015 to the current level around US75 cents. Overall, the economic and financial metrics remain encouraging. Australia has underlying inflation below the Reserve Bank’s 2%-3% target band at 1.6%, economic growth is at 3½-year highs of 3.1%, the cash rate is at record lows of 1.75%, and unemployment is near 3-year lows at 5.7%. Housing is also providing the momentum for the economy with home building and purchase especially driving the NSW, Victorian and ACT economies. All of this is likely to support corporate earnings and the economy’s ‘rebalancing’.
Therefore, looking forward, we forecast the Australian economy to grow around 3.2% in calendar 2016 and then 2.7% in 2017.
Share market outlook
The Australian share market is currently valued on a forward consensus price earnings ratio of 15.1x, which is 5% above the long term average of 14.4x. However, the forward consensus dividend yield for the Australian share market is an attractive 4.8% (80% franked) and this continues to attract investors searching for yield, particularly given the record low interest rates that currently prevail. As a result, we maintain our December 2016 forecast of up to 5,500 points for the S&P/ASX 200, implying capital growth of 5% before dividends from the close of 5,233 on 30 June 2016.
While the Australian share market is likely to experience some increased volatility from global uncertainty, it should be noted that only around 5% of aggregate earnings are derived from the UK and Europe. BREXIT is a political crisis with some adverse economic consequences, especially in Europe, but it is not a global financial crisis. We recommend investors should “let the dust settle” and start preparing themselves to “buy the share market dip”.
Bell Potter Securities is a leading Australian stockbroking, investment and financial advisory firm that provides a comprehensive offering of financial services to a diversified client base that includes individuals, institutions and corporations.