After strong year for returns from Australasian equity markets, investors are asking: what does 2018 offer? Are the ‘goldilocks’ conditions of solid economic growth, low inflation and easy monetary policy settings likely to continue to support equity market returns?
While we believe the near-term outlook for local equity returns remains positive, two scenarios may challenge these goldilocks ‘not too hot, not too cold’ conditions.
Challenge 1: Earnings growth fails to meet expectations.
Market consensus is for local equity markets to generate mid-to-high single digit earnings growth per annum over the next few years. Key near-term risks to earnings forecasts are a) a rapid tightening in monetary conditions, and b) the consequences of possible government policy changes which might slow economic growth.
If monetary policy settings (including official interest rate targets and macro-prudential tools) are tightened too quickly, earnings may disappoint, as constrained access to debt capital slows economic growth and higher interest rates hit business profitability. Current above-average economic growth may give central banks globally the confidence to ‘tap the breaks’, and unwind supportive post global financial crisis (GFC) monetary policy stimulus. But lead global inflation indicators remain low, meaning central bankers don’t have to act too quickly to increase interest rates. With central bankers globally maintaining a gradual approach to unwinding easy monetary policy settings, we believe the equity market risks related to near-term sharp hikes in monetary policy settings remain modest...