Broadly positive outlook for Australian equities
Australian equities rallied in the first quarter; however, the positive momentum slowed in March, when the Index added only 0.85%.
While there has been a marked improvement in investor sentiment since the end of 2011, the outlook for global growth remains lacklustre. Citi forecasts world GDP growth of 2.5% for 2012, at the same time noting that significant downside risks still remain. The worst fears related to the European sovereign debt crisis have been allayed but the issues have not yet been fully resolved. In addition the downward trend in Chinese economic data releases is exerting a dampening effect on market sentiment, particularly in Australia.
These views were echoed in the April RBA monetary policy announcement. Interest rates were held at 4.25%, but Governor Stevens paved the way for a 0.25% cut in May, contingent upon forthcoming data confirming that inflationary pressures remain under control. The Board lowered their 2012 growth outlook for Australia to a rate below the long-term trend.
The apparent change in stance by the RBA caused an immediate reaction in currency and bond markets. The market is currently expecting a cut of 0.25% in May, and a further 0.75% of cuts before the end of the year. The Australian dollar traded lower immediately following the announcement and the sell-off versus the US dollar was compounded when the US Federal Open Market Committee (FOMC) minutes later showed that hopes of a third round of quantitative easing from the Federal Reserve may have been exaggerated.
Citi analysts expect that interest rates will only see a single cut of 0.25% in May. Despite this, Citi retains a broadly positive outlook for the Australian equity market. Citi's equity strategists see earnings growth increasing from around 0% in 2012 to between 5% and 10% in 2013, with the year end target for the S&P/ASX200 remaining unchanged at 4750. The lower AUD/USD exchange rate will be positive for stocks, and although Chinese growth may be slowing, it is likely to remain at levels that will support commodity prices at current levels.
It is worth noting that a significant proportion of this growth reflects the fact that certain sectors have seen unusual operating conditions leading to share price underperformance. These sectors include insurance, contractors and steel. As conditions improve, these sectors should generate earnings growth without necessarily depending on a pick up in the broader economic activity. As this improvement in earnings becomes priced in, equity prices should finish 2012 higher.