iInvest Eye On The Market – July 2016

Outlook for Investment Markets

Like many other equity markets, Australia’s has been sideswiped in the past week by increased levels of investor nervousness over Brexit. The S&P/ASX200 Index is now down 1.7% in capital value since the start of the year. Adding on the value of dividend income puts investors marginally in credit, with a total overall return of 0.3%.

For the year to date, the miners have done best (capital gain of 19.2%), followed by industrials (6.9%), and there was also a small (1.8%) gain for consumer discretionary stocks. But overall performance was held back by the weak performance of the large financials sector, which has lost 8.0%, and to a lesser extent by weak consumer staples stocks (loss of 5.7%) and IT shares (loss of 2.5%).

In Australia, there was unexpectedly strong gross domestic product growth in the March quarter; the economy grew by 3.1% over the year to March compared with the 2.7% consensus forecast. Other, more recent data point to the economy continuing to perform reasonably well. The Australia Industry Group’s latest (May) sectoral indexes show that manufacturing has now been expanding for 11 months in a row, the services sector (the largest in the economy) moved into clear expansion mode during the month, and only construction went backwards, mainly because of the oversupplied apartment sector.

The latest (May) monthly business survey from National Australia Bank was also encouraging. Business “confidence” may have dropped a little–the NAB team suggested the general election may have played some part–but “confidence” tends to be a fickle indicator. A better insight into what is happening is NAB’s measure of business “conditions,” which is a mix of what is actually happening to businesses’ sales, profits, and employment. NAB’s conditions measure is much more upbeat: As NAB commented, “Business conditions remained at an elevated level in May (at +10 index points), which is an above-average result and close to post-GFC highs…The elevated level of business conditions (unchanged from last month) was due to a notable improvement in trading (sales) and profitability, which offset a disappointing moderation in employment demand.”

The strong profitability reading is especially important. The latest official data on company profits had disappointed: Analysts expected companies’ gross operating profits to be roughly unchanged in the March quarter compared with the December 2015 quarter, but in the event profits fell by 4.7% (seasonally adjusted) or, alternatively, by 3.1% on the statisticians’ “trend” basis, which tries to detect the underlying pattern behind the usual statistical volatility. Either way, it was not encouraging: Analysts had hoped that profits in the non-mining parts of the economy would by now have been enough to make up for the substantially lower profits in the mining sector. In the event, in the year to March, mining profits were indeed down, by 21.7%, but non-mining profits were also down, by 3.3%.

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