Investors would be wise to consider some insurance against a negative outcome to trade disputes, writes Morningstar's Peter Gee in his latest economic update.

In cash and fixed interest, the Reserve Bank of Australia indicated early last month an upward move in the cash rate would be more likely than a decrease – even though there remained no strong case for a near-term adjustment.

"It is possible that the current cyclical pickup could see the RBA bringing forward the date of an eventual rate hike, but whatever the exact timing low short-term rates look very likely in place for some time," says Gee.

fed cash rate interest rates global economy

The US Federal Reserve has indicated it will continue to raise rates

The RBA today left the cash rate unchanged for the 24th consecutive time at 1.5 per cent. 

Gee thinks local bond yields will likely revert to their previous relationship with US yields, and head higher as well.

Ongoing weakness in the Australian dollar "looks a plausible outcome, but as always with currency forecasting, a wide range of factors is in play," Gee says. While the Aussie's latest closing price was US 74 cents, Commonwealth Bank forecasts suggest it could bounce back to US 76 cents in a year.

Reasonable A-REIT conditions

Outside of retail property, the outlook for Australian real estate investment trusts is reasonably good, Gee says, and recent evidence suggests conditions could get better again in coming months.

"As any number of research reports have said, retail, other than the very large 'event' or 'destination' shopping malls, continues to be overshadowed by the threat from online shopping," he says.

The local launch of Amazon earlier this year, and further "tactical marketing initiatives" from the likes of eBay, are part of this threatening outlook.

"But absent any unexpectedly sharp rise in bond yields, improving operating conditions suggest that the A-REIT sector should be able to generate some further modest capital gains," says Gee.

Progressive improvement in business confidence

A recent National Australia Bank quarterly business survey says "Overall, conditions remain favourable, and a pattern of broad-based strength remains evident at the industry level, with most industries at or above average in Q2".

However, how much of the cyclical improvement flows through to higher share prices is a crucial question.

"There are still likely to be some sectoral headwinds," Gee says. Bank profits remain under a cloud, and the resources sector is exposed to global trade shocks.

However, some commentators, including Credit Suisse, suggest these risks are offset by expected profits in other areas, such as industrials.

Fixed interest outlook is problematic

Gee thinks it likely that monetary policy settings will be "gradually readjusted to be less supportive than previously, and that rising bond yields will lead to ongoing capital losses".
He refers to comments from Jerome Powell, chair of the Fed, indicating it would continue to raise rates. Other central banks are also "inching closer to the starting line for normalisation of monetary policy," says Gee.

European Central Bank forecasters expect some announcement on policy direction by next March, with a chance of a small increase in ECB rates by September.

Weighing up differing viewpoints on global inflation, Gee says: "on balance, the view of ongoing global growth still looks more likely. As surveys of fund manager allocations have shown, managers are hedging their bets."

Contrasting fortunes between US and rest of world

While US equities have outperformed in a number of positive US-specific factors, the same has not occurred in the global economy.

"The global economy has been somewhat under a cloud as fears over protectionism have risen," Gee says.

Referring to research from IHS, Gee says only two countries grew more optimistic about the business outlook – India and the US.

"Trade wars are also on investors' minds … now seen as by far the biggest risk facing equity markets," Gee says, referring to a Bank of America Merrill Lynch fund manager survey.

However, on the positive side, he also notes global economies have weathered various risks, including eurozone financial stress, a China slowdown and fears of rapidly rising US interest rates.

"This time may be no different … but that is not how fund managers see it. They have clearly turned more bearish in the BAML survey," says Gee. The survey results show the lowest level of optimism since early 2016, as fund managers become pessimistic about the outlook for profits over the next year.

"On balance, the global economy may well continue to stumble through this latest challenge," says Gee.

"It has been a volatile year to date, and more of the same looks likely while the interplay between ongoing expansion and protectionist policy works its way through."

 

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Glenn Freeman is senior editor, Morningstar Australia.

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