Olivers Insights

Key points: 

• For the first time since 2012 China has cut interest rates. Borrowing costs have been too high in China so rate cuts will help support economic growth. Expect more interest rate cuts ahead.

• The rate cut is positive for Chinese shares which remain relatively cheap.

• China’s rate cut highlights that global monetary conditions are still easing with monetary easing in Japan, Europe and China taking over from the end of quantitative easing in the US.

• Chinese easing is also positive for commodities and Australian shares.

Download pdf version "China cuts interest rates" 

After resisting traditional monetary stimulus measures in favour of various “mini stimulus” initiatives the People’s Bank of China (PBOC) has finally cut interest rates, reducing the 12 month benchmark lending rate by 0.40% to 5.6% and the 12 month benchmark deposit rate by 0.25% to 2.75%.

Source: Bloomberg, AMP Capital

Our assessment is that this is a good, overdue move as relatively high interest rates have been holding back Chinese growth this year. This note looks at the main issues and implications for investors.

Chinese growth has slowed

Chinese growth has slowed significantly compared to the 10% plus rate seen last decade and for the last few years has been running around 7 to 8%. The downshifting in growth reflects several factors:

• The Chinese Government has come to the view that 10% plus growth is not sustainable as it has led to various social and economic imbalances in the economy, including strong growth in debt, inequality, pollution and corruption. In particular the new leadership has been focused more on economic reform than growth for growth’s sake.

Source: Bloomberg, AMP Capital

• Soft global growth has weighed on Chinese exports.

• More recently, a downturn in the property market – in terms of construction & prices – has weighed on growth.

Source: Bloomberg, AMP Capital

• Monetary policy has arguably been too tight as the PBOC has sought to rein in growth in credit through the “shadow banking” sector (ie outside of the more regulated banks).

Reflecting the last two factors, the slowdown in growth has become more noticeable this year with a range of indicators losing momentum including industrial production, retail sales, fixed asset investment and money supply and credit.

Source: Thomson Reuters, AMP Capital

While assuring that growth would come in “around” the 7.5% target for this year, the current Government has been keen to distance itself from the previous government and the negative connotations that the “stimulative policy” response to the global financial crisis has. As such it has focused more on structural reforms to revitalise long term growth and responded to periods of weaker data with “targeted easing” and “mini stimulus” measures. These include: rebuilding shanty towns; increased railway spending; accelerated depreciation and other policy support for small business; the relaxation or removal of measures designed to slow the property market; lower money market interest rates; and liquidity injections into the banks.

However, the continued loss of growth momentum lately despite these measures has suggested that they are not enough and that the risks to growth may be shifting below 7%. In particular with private sector investment slowing rapidly, inflation falling and producer prices in deflation for nearly three years it was clear that monetary conditions were too tight and interest rates too high. For example, anecdotes suggest smaller private firms have been facing an effective cost of borrowing of 15 to 20% from the shadow banking system. While the Government may have been prepared to tolerate this as long as employment growth held up, slowing economic growth will eventually hit employment as it is a lagging indicator, Furthermore, employment readings in business conditions surveys have been trending down.

So at last the PBOC has recognised this and started to cut interest rates. Our assessment is that:

• The rate cut clearly signals that the Chinese Government is determined to support growth.

• More rate cuts are likely as borrowing costs remain too high and in any case the PBOC rarely cuts just once. The lending rate could fall to 4.5% next year.

• Cutting rates is the most effective way to cut borrowing costs as bank lending rates are still largely priced off the benchmark rate and are mostly above it. Rate cuts will benefit private sector companies that have been paying very high interest rates and households with housing debt. It won’t stop a gradual structural slowing in Chinese growth (due to demographics and as the industrialisation phase slows) but it adds to confidence that China will avoid the hard landing many still see around the next corner. After growth of around 7.5% this year, expect growth of around 7% next year.

• Reform remains the main focus in China, but it was always contingent on growth holding up.

The China worry list

But what about the China worries we regularly hear about from China bears regarding: the need to rebalance the economy; falling competitiveness; a housing bubble; excessive growth in debt; and the shadow banking system. Our assessment has been that these problems are exaggerated¹. In particular:

The investment/consumption imbalance is exaggerated – as consumption is understated relative to investment in China, investment per capita is low and reducing investment too quickly will only risk China going down the same inflation/trade deficit path seen in many other emerging countries. So any adjustment needs to be gradual.

China is not losing its competitiveness – wages growth is being offset by rapid productivity growth, China is still gaining global export share and inflation is low and falling.

There has been no generalised housing bubble – household debt is low at 30% of GDP, house prices have not kept up with incomes and there is an undersupply of affordable housing. Yes there has been excessive development in some cities, but this not the first tier cities.

Rapid rise in debt, with credit up 22% pa over the last decade, is a concern but – total debt relative to GDP is not excessive globally and strong growth in debt reflects China’s 50% savings rate with savings mainly being recycled via debt. Lowering lending and hence investment too quickly without first lowering saving will risk recession and deflation.

Finally, China’s “shadow banking” system (ie, lending occurring outside the banks) has grown rapidly but – it is still relatively small (30% of banking assets versus 100% in the US), lacks leverage, lacks complexity and lacks heavy foreign exposure. So it’s certainly not comparable to the risks around US shadow banking that drove the GFC.

Overall our assessment is that these risks are manageable, provided the Government does not make a policy mistake. Its move to cut interest rate is a sign that it is well aware of this risk. Unlike in western countries, much of what goes on in China is controlled by the Government, and this includes the current slowdown. And the Government has plenty of firepower to ensure growth holds up.

The Chinese share market

After a long bear market since August 2009 which left them very cheap, Chinese share are up around 18% so far this year. Despite this they remain relatively cheap with a price to historic earnings ratio of 10.9 and a forward PE of 9.1. The PBOC rate cut adds to their attractiveness from a valuation perspective and in terms of providing confidence regarding future earnings growth.

Source: Thomson Reuters, AMP Capital

Global and Australian implications

China’s rate cut adds to the determination of global policy makers to avoid deflation and support growth. While US quantitative easing may have ended, it’s being replaced by QE in Japan and Europe and rate cuts in China. And rate hikes are a fair way off in the US and a long way off in Australia. This in turn augurs well for shares and other growth assets.

The Chinese rate cut and the signal of determination to support growth it provides is also positive for commodity prices and the Australian share market. While a return to a secular bull market in commodities and relative outperformance by Australian shares is unlikely, both have been oversold lately and China’s move could provide the trigger for a decent rally into year end.

Dr Shane Oliver
Head of Investment Strategy and Chief Economist
AMP Capital

¹See “Chinese debt worries and growth”, Oliver’s Insights, February 2014.

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.

Key points: 

• Starting point valuations – eg yields and price to earnings multiples – are a key driver of potential medium term investment returns. This is particularly so for cash and bonds, and for shares and growth assets at extremes. 

• At present valuation starting points for term deposits and bonds suggest low medium term returns. For shares they suggest okay returns.

Download pdf version " Starting point valuations matter, a lot" 

The cheaper the better

A valuation measure for an asset is basically a guide to whether it’s expensive or cheap. Simple valuation measures are price to earnings ratios for shares (the lower the better) and income yields, ie the ratio of dividends, rents or interest payments to the value of the asset (the higher the better).

An obvious example of where the starting point valuation matters critically is cash. If the yield or interest rate on offer from a term deposit rate is relatively high then that is good because that is precisely the return you will get. For example, five years ago average term deposit rates for multiyear bank term deposits were around 7% pa with some banks offering deals around 8%. This was not bad for a safe asset in a world of inflation averaging around 2.5%. So the starting point for term deposits then was attractive. Now by contrast, term deposit rates are averaging closer to 3% suggesting that they are not such good value anymore.

Source: RBA, AMP Capital

For government bonds the yield is similarly a good guide to starting point value. Over short term periods bond prices can move up and down and so influence short term returns, but over the medium term the main driver of the return a bond investor will get is what bond yields were when they invested. If the yield on a 10 year bond is 5%, then if you hold the bond to maturity your return will be 5%. Of course a portfolio of bonds will reflect a range of maturities and so the relationship is not as perfect, but it can be seen in the next chart which shows a scatter plot of Australian 10 year bond yields since 1950 (along the horizontal axis) against subsequent 10 year returns from Australian bonds based on the Composite All Maturities Bond index (vertical axis).

Source: Global Financial Data, Bloomberg, AMP Capital

Put simply when bond yields are high they drive high bond returns over the medium term and vice versa. For example when Australian 10 year bond yields in January 1982 were 15.2% it’s not surprising that returns from bonds over the subsequent ten years were 15.4%. Similarly when bond yields were just 3.1% in January 1950, it’s no surprise that returns from bonds over the next 10 years were 3.1%.

For shares a similar relationship holds. The following chart shows a scatter plot of the price to earnings ratio for US shares since 1900 (along the horizontal axis) against subsequent 10 year total returns (ie dividends plus capital growth) from US shares. While the relationship is not as smooth as that for bonds because there is much more involved in share returns, it can be seen that it is a negative relationship, ie when share prices are relatively high compared to earnings subsequent returns tend to be relatively low and vice versa. The best time for shares seems to be when PEs are in single digits. At the end of the mid- 1970s bear market the PE had fallen to 7.6 times and over the next ten years US shares returned 15.6% pa.

Source: Global Financial Data, Bloomberg, AMP Capital

The next chart shows the same for Australian shares but only back to 1962 as an Australian PE series is not available prior to the 1960s. Again there is the expected negative relationship between the level of the PE and subsequent total returns (based on the All Ords Accumulation index). For example, at the end of the mid-1970s bear market in September 1974 the PE was just 5.4 times which was a great time to buy shares as over the next ten years Australian shares had a total return of 21.8% pa.

Source: RBA, Global Financial Data, AMP Capital

There is a dividend yield for Australian shares back to 1900 and the rough relationship in the next chart indicates the higher it is the better the subsequent 10 year share return.

Source: Global Financial Data, Bloomberg, AMP Capital

The key point is that the starting point matters. Critically for cash, bank deposits and bonds but also for growth assets like shares. Put simply, the higher the yield on offer the better and the lower the price to earnings ratio the better.

Why valuation is often forgotten

But while this seems obvious it’s often forgotten for three reasons.

The first relates to shares but is rather academic and goes back to the efficient market hypothesis which basically posits that the share market rationally reflects all publicly available information at any point in time. From this it follows starting point valuation measures will be no guide to future returns. Quite clearly this is not the case. But for a long time the argument that share markets were efficient drove a set and forget mentality to much investment strategy.

The second reason relates to the unfortunate reality that many investors pay too much attention to recent performance, so after a run of strong years investors gain confidence and expect it will continue and vice versa after a run of poor years. This leads many to buy only after good times only to find they have bought when shares are overvalued and therefore find themselves locked into poor returns. And vice versa after bad times. So just when starting point valuations matter the most, they tend to be ignored.

Finally, using valuation alone to drive investment decisions can involve pitfalls that can erase confidence in them.

Complications to be aware of

There are several potential pitfalls with valuation measures that investors should be aware of. First, sometimes assets are cheap for a reason (value traps). This is more often a phenomenon associated with individual shares, eg, a tobacco company subject to impending law suits even though its current earnings are fine. Or high yields may be being financed by debt. These traps can really only be picked up by thoroughly researching the investment.

Second, valuation measures are often a poor guide to timing. Eg, in 1996 US shares were starting to look expensive on some measures with Fed Chair Alan Greenspan and Economist Robert Shiller referring to “irrational exuberance” but if an investor sold shares short then they would have lost out as they rose for another four years. The best way to guard against this is to have a thorough asset allocation process that depends on more than just valuations.

Third, there is a huge array of valuation measures particularly when it comes to shares. For example the “earnings” in the PE calculation can be actual historic earnings, consensus earnings for the year ahead or earnings that have been smoothed in some way to remove cyclical distortions. All have their pros and cons. For example, the historic PE is based on actual data with no forecasting or manipulation but it can give the wrong signal during a recession as earnings may have collapsed more than share prices and so the PE may not give a reliable buy signal.

Finally, the appropriate level of valuation can vary depending on the environment. For example, in a period of low inflation it’s well-known that assets can trade on lower yields as the interest rate/yield structure in the economy falls. This in turn means higher PEs. So low inflation, say down to around 2%, can be good for shares via higher PEs as evident in the next chart for the US. But if inflation goes from “low” to deflation it can be bad as it tends to be associated with poor economic growth and as a result shares trade on lower PEs.

Source: Global Financial Data, Bloomberg, AMP Capital

The message from all this is that valuation is important but you ideally need to assess it with other indicators if you are trying to time market moves. The key is to allow that when a range of valuations measures are at an extreme then they are probably providing a signal that should not be ignored.

Current valuation signals

Right now starting valuation signals are as follows:

Bank term deposits – term deposit rates are low so returns will be low, at around 3%. This will remain the case until interest rates start to rise again.

Bonds – bond yields are now very low at 2.8% for Australian five year bonds and 3.3% for 10 year bonds and even less internationally pointing to low medium term returns from government bonds. In a world of excess savings, spare capacity and uneven growth it’s hard to get bearish on bonds but low yields nevertheless point to low medium term returns.

Shares – PE ratios for shares are no longer dirt cheap, but nor are they at the extreme expensive end suggesting that they are not providing strong signals at present. For US and Australian shares they are in ranges suggesting okay returns. This is particularly so relative to low bond yields.

Property – while this note has not focused on property the same basic principles apply, ie the higher the rental yield the better. Over the last few decades property yields have fallen with inflation and interest rates, but this is more so for residential property where gross rental yields are now quite low at around 3-4% compared to commercial property where yields average around 6-7%. So the starting point for commercial property is arguably much better.

Dr Shane Oliver
Head of Investment Strategy and Chief Economist
AMP Capital

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided. 

Key points: 

• Starting point valuations – eg yields and price to earnings multiples – are a key driver of potential medium term investment returns. This is particularly so for cash and bonds, and for shares and growth assets at extremes. 

• At present valuation starting points for term deposits and bonds suggest low medium term returns. For shares they suggest okay returns.

Download pdf version " Starting point valuations matter, a lot" 

The cheaper the better

A valuation measure for an asset is basically a guide to whether it’s expensive or cheap. Simple valuation measures are price to earnings ratios for shares (the lower the better) and income yields, ie the ratio of dividends, rents or interest payments to the value of the asset (the higher the better).

An obvious example of where the starting point valuation matters critically is cash. If the yield or interest rate on offer from a term deposit rate is relatively high then that is good because that is precisely the return you will get. For example, five years ago average term deposit rates for multiyear bank term deposits were around 7% pa with some banks offering deals around 8%. This was not bad for a safe asset in a world of inflation averaging around 2.5%. So the starting point for term deposits then was attractive. Now by contrast, term deposit rates are averaging closer to 3% suggesting that they are not such good value anymore.

Source: RBA, AMP Capital

For government bonds the yield is similarly a good guide to starting point value. Over short term periods bond prices can move up and down and so influence short term returns, but over the medium term the main driver of the return a bond investor will get is what bond yields were when they invested. If the yield on a 10 year bond is 5%, then if you hold the bond to maturity your return will be 5%. Of course a portfolio of bonds will reflect a range of maturities and so the relationship is not as perfect, but it can be seen in the next chart which shows a scatter plot of Australian 10 year bond yields since 1950 (along the horizontal axis) against subsequent 10 year returns from Australian bonds based on the Composite All Maturities Bond index (vertical axis).

Source: Global Financial Data, Bloomberg, AMP Capital

Put simply when bond yields are high they drive high bond returns over the medium term and vice versa. For example when Australian 10 year bond yields in January 1982 were 15.2% it’s not surprising that returns from bonds over the subsequent ten years were 15.4%. Similarly when bond yields were just 3.1% in January 1950, it’s no surprise that returns from bonds over the next 10 years were 3.1%.

For shares a similar relationship holds. The following chart shows a scatter plot of the price to earnings ratio for US shares since 1900 (along the horizontal axis) against subsequent 10 year total returns (ie dividends plus capital growth) from US shares. While the relationship is not as smooth as that for bonds because there is much more involved in share returns, it can be seen that it is a negative relationship, ie when share prices are relatively high compared to earnings subsequent returns tend to be relatively low and vice versa. The best time for shares seems to be when PEs are in single digits. At the end of the mid- 1970s bear market the PE had fallen to 7.6 times and over the next ten years US shares returned 15.6% pa.

Source: Global Financial Data, Bloomberg, AMP Capital

The next chart shows the same for Australian shares but only back to 1962 as an Australian PE series is not available prior to the 1960s. Again there is the expected negative relationship between the level of the PE and subsequent total returns (based on the All Ords Accumulation index). For example, at the end of the mid-1970s bear market in September 1974 the PE was just 5.4 times which was a great time to buy shares as over the next ten years Australian shares had a total return of 21.8% pa.

Source: RBA, Global Financial Data, AMP Capital

There is a dividend yield for Australian shares back to 1900 and the rough relationship in the next chart indicates the higher it is the better the subsequent 10 year share return.

Source: Global Financial Data, Bloomberg, AMP Capital

The key point is that the starting point matters. Critically for cash, bank deposits and bonds but also for growth assets like shares. Put simply, the higher the yield on offer the better and the lower the price to earnings ratio the better.

Why valuation is often forgotten

But while this seems obvious it’s often forgotten for three reasons.

The first relates to shares but is rather academic and goes back to the efficient market hypothesis which basically posits that the share market rationally reflects all publicly available information at any point in time. From this it follows starting point valuation measures will be no guide to future returns. Quite clearly this is not the case. But for a long time the argument that share markets were efficient drove a set and forget mentality to much investment strategy.

The second reason relates to the unfortunate reality that many investors pay too much attention to recent performance, so after a run of strong years investors gain confidence and expect it will continue and vice versa after a run of poor years. This leads many to buy only after good times only to find they have bought when shares are overvalued and therefore find themselves locked into poor returns. And vice versa after bad times. So just when starting point valuations matter the most, they tend to be ignored.

Finally, using valuation alone to drive investment decisions can involve pitfalls that can erase confidence in them.

Complications to be aware of

There are several potential pitfalls with valuation measures that investors should be aware of. First, sometimes assets are cheap for a reason (value traps). This is more often a phenomenon associated with individual shares, eg, a tobacco company subject to impending law suits even though its current earnings are fine. Or high yields may be being financed by debt. These traps can really only be picked up by thoroughly researching the investment.

Second, valuation measures are often a poor guide to timing. Eg, in 1996 US shares were starting to look expensive on some measures with Fed Chair Alan Greenspan and Economist Robert Shiller referring to “irrational exuberance” but if an investor sold shares short then they would have lost out as they rose for another four years. The best way to guard against this is to have a thorough asset allocation process that depends on more than just valuations.

Third, there is a huge array of valuation measures particularly when it comes to shares. For example the “earnings” in the PE calculation can be actual historic earnings, consensus earnings for the year ahead or earnings that have been smoothed in some way to remove cyclical distortions. All have their pros and cons. For example, the historic PE is based on actual data with no forecasting or manipulation but it can give the wrong signal during a recession as earnings may have collapsed more than share prices and so the PE may not give a reliable buy signal.

Finally, the appropriate level of valuation can vary depending on the environment. For example, in a period of low inflation it’s well-known that assets can trade on lower yields as the interest rate/yield structure in the economy falls. This in turn means higher PEs. So low inflation, say down to around 2%, can be good for shares via higher PEs as evident in the next chart for the US. But if inflation goes from “low” to deflation it can be bad as it tends to be associated with poor economic growth and as a result shares trade on lower PEs.

Source: Global Financial Data, Bloomberg, AMP Capital

The message from all this is that valuation is important but you ideally need to assess it with other indicators if you are trying to time market moves. The key is to allow that when a range of valuations measures are at an extreme then they are probably providing a signal that should not be ignored.

Current valuation signals

Right now starting valuation signals are as follows:

Bank term deposits – term deposit rates are low so returns will be low, at around 3%. This will remain the case until interest rates start to rise again.

Bonds – bond yields are now very low at 2.8% for Australian five year bonds and 3.3% for 10 year bonds and even less internationally pointing to low medium term returns from government bonds. In a world of excess savings, spare capacity and uneven growth it’s hard to get bearish on bonds but low yields nevertheless point to low medium term returns.

Shares – PE ratios for shares are no longer dirt cheap, but nor are they at the extreme expensive end suggesting that they are not providing strong signals at present. For US and Australian shares they are in ranges suggesting okay returns. This is particularly so relative to low bond yields.

Property – while this note has not focused on property the same basic principles apply, ie the higher the rental yield the better. Over the last few decades property yields have fallen with inflation and interest rates, but this is more so for residential property where gross rental yields are now quite low at around 3-4% compared to commercial property where yields average around 6-7%. So the starting point for commercial property is arguably much better.

Dr Shane Oliver
Head of Investment Strategy and Chief Economist
AMP Capital

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided. 

Key points: 

• A combination of the blanket news coverage of economic worries, the associated information avalanche we are now exposed to and our innate fascination with crises is likely making us worse investors: more fearful, more jittery and more focussed on the short term. 

• Investors should recognise that shares climb a wall of worry, try and turn down the “news” volume, focus on investing for the long term, and remember the best time to invest is when everyone is gloomy.

Download pdf version " Try to turn down the noise" 

About two months ago I had all my wisdom teeth out – well rather the top teeth were pulled and the bottom teeth chopped off. The day this was to happen a speed test I was running on my iPad was interrupted by an ad screaming “The Australian Recession of 2014: why it’s inevitable, click here to find out how to protect your wealth” (for a fee) and the headline on the front page of the AFR was "Economy enters the danger zone”. Needless to say all this gloom did nothing to cheer me ahead of the trip to the dentist!

This year has seen an endless list of worries. Ukraine, a property collapse in China, the end of quantitative easing and talk of rate hikes in the US, global deflation, renewed weakness in Europe, the Insurgent Savagery (IS) in Iraq, protests in Hong Kong, Ebola, Australian Budget cutbacks, the collapse of the iron ore price, etc.

But last year was the same with the US fiscal cliff, worries about Italy and Spain, Cyprus (remember how the bailout of Cypriot banks was going to destroy the European banking system!), the sequester, Fed taper talk, Syria, the US Government shutdown and debt ceiling, Fed tapering, etc.

2012 was just as packed with worries – remember the one about the end of the world according to the Mayan calendar that was going to happen on December 21. I actually went to sleep that night with fingers crossed fearing the end was nigh, woke up the next morning with relief only to realise that if the world was to end it would surely happen in the US time zone so as to make the movie. And even then it didn’t end!

Going by much financial commentary and the questions I get from investors it seems there are lots of things about to drag us into the next financial crisis: budget deficits, debt, money printing, the Euro, hyperinflation, deflation, taxes, welfare spending, banks, retiring baby boomers, the government, Obamacare, peak oil, pollution, global warming, war in the Middle East, terrorism, Russia, China, a pandemic. The expected result is always horrible with a massive loss of wealth, rising unemployment and maybe even the collapse of civilisation.

The perpetual worry list and the ongoing doom and gloom has me wondering. Is there anything new in this? Why the fascination with doom and gloom? And is the avalanche of economic and financial information we are now seeing with the IT revolution making things seem worse?

Worry, worry, worry – but nothing new

While not to deny the current worry list, it’s really nothing new. The global economy has had plenty of difficult phases in the past. And it got over them. Here is a list from the last century. 1906 San Francisco earthquake; 1907 US financial panic; WWI; 1918 Spanish flu pandemic (up to 50 million killed); The Great Depression; WW2; Korean War; 1957 flu pandemic; 1960 credit crunch; Cuban missile crisis; Vietnam War; 1968 flu pandemic; 1973 OPEC oil embargo; Watergate; stagflation in the 1970s; apparent death of Elvis in 1977; Iranian revolution/second oil crisis; Latin American debt crisis; Chernobyl nuclear disaster; 1987 share crash; First Gulf War; Japanese bubble economy collapse; US Savings and Loan crisis; Second Gulf War; Asian crisis; Tech wreck; 9/11 terrorist attacks; Lehman Brothers collapse; and the Eurozone public debt crisis.

And prognostications that the world is about to bump into a physical limit, causing some sort of “great disruption”, have regularly been made over the last two hundred years. Thomas Malthus, Paul Ehrlich’s The Population Bomb of 1968, the Club of Rome report on the Limits to Growth in 1972, the “peak oil" fanatics who keep telling me I will have to ditch the Holden and get a horse and buggy, etc. Such Malthusian analyses dramatically underestimate resources, the role of price increases in driving change and human ingenuity in facilitating it.

And when you're reading books like those from Harry S Dent about The Great Depression Ahead (2009), The Great Crash Ahead (2011) and The Demographic Cliff (2014) just recall that there has long been a particular fascination with “the coming financial crisis”. Google those words and you’ll find 37 million search results including: 8 reasons why a new global financial crisis could be on the way; How to deal with the coming economic crisis; The coming “tsunami of debt” and financial crisis in America; The next big crisis? Think 2008 only worse; and Why you will be blinded by the next financial crisis. Yeah right!

Amongst my favourites are Ravi Batra’s The Great Depression of 1990, well that didn't happen so it was just delayed to The Crash of the Millennium that foresaw an inflationary depression which didn't happen either. No worries. The point is usually to scare enough people into buying the books and make millions in the process!

And yet despite this litany of problems and continuous prognostications of doom, since 1900 US shares have returned 9.8% per annum (or 6.5% pa after inflation) and Australian shares 11.9% pa (or 7.8% pa after inflation).

Source: ASX, AMP Capital

It could be the world is more problematic than it used to be, but this seems doubtful. When I think of what my parents went through – Great Depression, infant sibling deaths, wars and severe recessions – I find it hard to agree life is harder today.

Or does it just seem that way?

I can't deny that there are things to worry about – and the money that can be made from promoting them. But I wonder whether the communications revolution we are seeing combined with human nature are making them seem worse than they really are? Information technology is great – but we are now bombarded by economic and financial news and opinions on a continuous basis via TV with finance updates, multiple news and finance channels, websites and blogs, twitter, or wrapping around a building.

The reality though is that much of this financial news is noise – random moves in economic data more due to statistical aberrations than fundamental swings in the economy, gyrations in share prices and currencies that reflect swings in sentiment on the day, constant chatter about what it all means. And of course it’s well known that "bad news sells". Do you ever wonder why we hear when a 1% fall in the shares wipes $16bn off the share market but not when a 1% rise adds $16bn?

But why does bad news sell? Perhaps the answer is that the human brain evolved during the Pleistocene age when the trick was to avoid being squashed by a wholly mammoth or eaten by a sabre tooth tiger. And so we are always on the lookout for risks.

This probably partly explains a couple of other things. First it’s long been observed that investors suffer from myopic loss aversion, ie a loss in financial wealth is felt much more distastefully than the beneficial impact of the same sized gain.

And secondly, as John Stuart Mill observed negative thinkers are more likely to be revered than positive. “I have observed that not the man who hopes when others despair, but the man who despairs when others hope, is admired by a large class of persons as a sage.” It invariably seems that higher regard is had for pessimists predicting disaster than optimists seeing better times. As JK Galbraith once observed “we all agree that pessimism is a mark of a superior intellect.” It seems that the human mind has been hard wired to always be on guard and so naturally attracted to doomsayers.

So talk of gloom and doom more readily finds a market than balanced commentary, because it appeals to our base instinct to look for risks around the corner.

The reality is that much of the noise around investment markets is nothing more than a soap opera. So much is going on and it’s invariably bad. An ordinary investor could be forgiven for thinking we are in a constant state of economic crisis, lurching from worrying about one potential catastrophe to another.

Help or hindrance

In theory the access to information that has come with the information and communications revolution has made us all more informed and surely this means investment markets should be more efficient than ever resulting in a better allocation of resources resulting in stronger long term growth and profits. And hence better returns for investors. However, sorry to disappoint but there is no sign of this.

To be sure, new information is now more quickly reflected in financial markets. But it’s hard to see any evidence that all the extra information is resulting in more rational pricing of shares and currencies. Financial markets are as volatile as ever. And we are still beset by periodic asset bubbles and busts. The next chart shows volatility in Australian and US shares is basically in the same range it’s been in over the last century.

Source: ASX, Global Financial Data, AMP Capital Investors

And there is no evidence of consistently higher returns for investors. Individual investors may even be worse off. Faced with a constant barrage of mostly negative news and worries, the distaste investors have for loss causes them to shorten their investment horizons and become excessively cautious, which means they are less likely to take risks which will ultimately mean lower long term returns.

And perhaps even more worryingly, the greater short term focus is arguably boosting short term “speculation” relative to medium to longer term “investment” in the economy which may adversely affect economic conditions and prosperity.

Put simply, there is a risk that the combination of the blanket coverage of worries via constant news, the associated information avalanche we are now exposed to and our innate fascination with crises is making us worse investors: more fearful, more jittery and more focussed on the short term. And this is bad for investors and bad for the economy.

What does it mean for investors?

Given all this there are four things investors should do.

• First, recognise that shares and other growth assets have historically climbed a wall of worry and they will most likely continue to do so. Yes there are always lots of worries out there. Sometimes they become real concerns but most of the time they come to nothing. In fact since 1900 Australian shares have risen 8 years out of ten.

• Second, turn the volume down on the “news” front, ie consume less of it. You'd be better watching less of the financial soap opera in favour of episodes of The Brady Bunch or The Partridge Family.

• Third, adopt a long term strategy and stick to it. The environment we are now in has increased the importance of asset allocation – but this is best left to experts and those who can really put the time in to filter the noise from fundamental signals. Most individual investors will end up getting it wrong so the best approach is to agree a long term strategy and stick to it.

• Finally, recognise that the best opportunities in investing often arise when many are engulfed by gloom and doom and the market is cheap.

And just a thought on forecasting

For those who think I am being a bit harsh on the prognosticators of doom, I will be the first to admit I have had a few misses too. My first manager used to say "forecasting is hard because it concerns the future" which sounds inane but it’s fundamentally true. But the key is to maintain historical perspective, realise that yes bad things do happen, and that all experts can be wrong at times (including me!), but that most of the time things turn out okay for the economy and growth assets. I think it’s better backing that than the 20% or so chance that they won't.

Dr Shane Oliver
Head of Investment Strategy and Chief Economist
AMP Capital

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.

Key points: 

• A combination of the blanket news coverage of economic worries, the associated information avalanche we are now exposed to and our innate fascination with crises is likely making us worse investors: more fearful, more jittery and more focussed on the short term. 

• Investors should recognise that shares climb a wall of worry, try and turn down the “news” volume, focus on investing for the long term, and remember the best time to invest is when everyone is gloomy.

Download pdf version " Try to turn down the noise" 

About two months ago I had all my wisdom teeth out – well rather the top teeth were pulled and the bottom teeth chopped off. The day this was to happen a speed test I was running on my iPad was interrupted by an ad screaming “The Australian Recession of 2014: why it’s inevitable, click here to find out how to protect your wealth” (for a fee) and the headline on the front page of the AFR was "Economy enters the danger zone”. Needless to say all this gloom did nothing to cheer me ahead of the trip to the dentist!

This year has seen an endless list of worries. Ukraine, a property collapse in China, the end of quantitative easing and talk of rate hikes in the US, global deflation, renewed weakness in Europe, the Insurgent Savagery (IS) in Iraq, protests in Hong Kong, Ebola, Australian Budget cutbacks, the collapse of the iron ore price, etc.

But last year was the same with the US fiscal cliff, worries about Italy and Spain, Cyprus (remember how the bailout of Cypriot banks was going to destroy the European banking system!), the sequester, Fed taper talk, Syria, the US Government shutdown and debt ceiling, Fed tapering, etc.

2012 was just as packed with worries – remember the one about the end of the world according to the Mayan calendar that was going to happen on December 21. I actually went to sleep that night with fingers crossed fearing the end was nigh, woke up the next morning with relief only to realise that if the world was to end it would surely happen in the US time zone so as to make the movie. And even then it didn’t end!

Going by much financial commentary and the questions I get from investors it seems there are lots of things about to drag us into the next financial crisis: budget deficits, debt, money printing, the Euro, hyperinflation, deflation, taxes, welfare spending, banks, retiring baby boomers, the government, Obamacare, peak oil, pollution, global warming, war in the Middle East, terrorism, Russia, China, a pandemic. The expected result is always horrible with a massive loss of wealth, rising unemployment and maybe even the collapse of civilisation.

The perpetual worry list and the ongoing doom and gloom has me wondering. Is there anything new in this? Why the fascination with doom and gloom? And is the avalanche of economic and financial information we are now seeing with the IT revolution making things seem worse?

Worry, worry, worry – but nothing new

While not to deny the current worry list, it’s really nothing new. The global economy has had plenty of difficult phases in the past. And it got over them. Here is a list from the last century. 1906 San Francisco earthquake; 1907 US financial panic; WWI; 1918 Spanish flu pandemic (up to 50 million killed); The Great Depression; WW2; Korean War; 1957 flu pandemic; 1960 credit crunch; Cuban missile crisis; Vietnam War; 1968 flu pandemic; 1973 OPEC oil embargo; Watergate; stagflation in the 1970s; apparent death of Elvis in 1977; Iranian revolution/second oil crisis; Latin American debt crisis; Chernobyl nuclear disaster; 1987 share crash; First Gulf War; Japanese bubble economy collapse; US Savings and Loan crisis; Second Gulf War; Asian crisis; Tech wreck; 9/11 terrorist attacks; Lehman Brothers collapse; and the Eurozone public debt crisis.

And prognostications that the world is about to bump into a physical limit, causing some sort of “great disruption”, have regularly been made over the last two hundred years. Thomas Malthus, Paul Ehrlich’s The Population Bomb of 1968, the Club of Rome report on the Limits to Growth in 1972, the “peak oil" fanatics who keep telling me I will have to ditch the Holden and get a horse and buggy, etc. Such Malthusian analyses dramatically underestimate resources, the role of price increases in driving change and human ingenuity in facilitating it.

And when you're reading books like those from Harry S Dent about The Great Depression Ahead (2009), The Great Crash Ahead (2011) and The Demographic Cliff (2014) just recall that there has long been a particular fascination with “the coming financial crisis”. Google those words and you’ll find 37 million search results including: 8 reasons why a new global financial crisis could be on the way; How to deal with the coming economic crisis; The coming “tsunami of debt” and financial crisis in America; The next big crisis? Think 2008 only worse; and Why you will be blinded by the next financial crisis. Yeah right!

Amongst my favourites are Ravi Batra’s The Great Depression of 1990, well that didn't happen so it was just delayed to The Crash of the Millennium that foresaw an inflationary depression which didn't happen either. No worries. The point is usually to scare enough people into buying the books and make millions in the process!

And yet despite this litany of problems and continuous prognostications of doom, since 1900 US shares have returned 9.8% per annum (or 6.5% pa after inflation) and Australian shares 11.9% pa (or 7.8% pa after inflation).

Source: ASX, AMP Capital

It could be the world is more problematic than it used to be, but this seems doubtful. When I think of what my parents went through – Great Depression, infant sibling deaths, wars and severe recessions – I find it hard to agree life is harder today.

Or does it just seem that way?

I can't deny that there are things to worry about – and the money that can be made from promoting them. But I wonder whether the communications revolution we are seeing combined with human nature are making them seem worse than they really are? Information technology is great – but we are now bombarded by economic and financial news and opinions on a continuous basis via TV with finance updates, multiple news and finance channels, websites and blogs, twitter, or wrapping around a building.

The reality though is that much of this financial news is noise – random moves in economic data more due to statistical aberrations than fundamental swings in the economy, gyrations in share prices and currencies that reflect swings in sentiment on the day, constant chatter about what it all means. And of course it’s well known that "bad news sells". Do you ever wonder why we hear when a 1% fall in the shares wipes $16bn off the share market but not when a 1% rise adds $16bn?

But why does bad news sell? Perhaps the answer is that the human brain evolved during the Pleistocene age when the trick was to avoid being squashed by a wholly mammoth or eaten by a sabre tooth tiger. And so we are always on the lookout for risks.

This probably partly explains a couple of other things. First it’s long been observed that investors suffer from myopic loss aversion, ie a loss in financial wealth is felt much more distastefully than the beneficial impact of the same sized gain.

And secondly, as John Stuart Mill observed negative thinkers are more likely to be revered than positive. “I have observed that not the man who hopes when others despair, but the man who despairs when others hope, is admired by a large class of persons as a sage.” It invariably seems that higher regard is had for pessimists predicting disaster than optimists seeing better times. As JK Galbraith once observed “we all agree that pessimism is a mark of a superior intellect.” It seems that the human mind has been hard wired to always be on guard and so naturally attracted to doomsayers.

So talk of gloom and doom more readily finds a market than balanced commentary, because it appeals to our base instinct to look for risks around the corner.

The reality is that much of the noise around investment markets is nothing more than a soap opera. So much is going on and it’s invariably bad. An ordinary investor could be forgiven for thinking we are in a constant state of economic crisis, lurching from worrying about one potential catastrophe to another.

Help or hindrance

In theory the access to information that has come with the information and communications revolution has made us all more informed and surely this means investment markets should be more efficient than ever resulting in a better allocation of resources resulting in stronger long term growth and profits. And hence better returns for investors. However, sorry to disappoint but there is no sign of this.

To be sure, new information is now more quickly reflected in financial markets. But it’s hard to see any evidence that all the extra information is resulting in more rational pricing of shares and currencies. Financial markets are as volatile as ever. And we are still beset by periodic asset bubbles and busts. The next chart shows volatility in Australian and US shares is basically in the same range it’s been in over the last century.

Source: ASX, Global Financial Data, AMP Capital Investors

And there is no evidence of consistently higher returns for investors. Individual investors may even be worse off. Faced with a constant barrage of mostly negative news and worries, the distaste investors have for loss causes them to shorten their investment horizons and become excessively cautious, which means they are less likely to take risks which will ultimately mean lower long term returns.

And perhaps even more worryingly, the greater short term focus is arguably boosting short term “speculation” relative to medium to longer term “investment” in the economy which may adversely affect economic conditions and prosperity.

Put simply, there is a risk that the combination of the blanket coverage of worries via constant news, the associated information avalanche we are now exposed to and our innate fascination with crises is making us worse investors: more fearful, more jittery and more focussed on the short term. And this is bad for investors and bad for the economy.

What does it mean for investors?

Given all this there are four things investors should do.

• First, recognise that shares and other growth assets have historically climbed a wall of worry and they will most likely continue to do so. Yes there are always lots of worries out there. Sometimes they become real concerns but most of the time they come to nothing. In fact since 1900 Australian shares have risen 8 years out of ten.

• Second, turn the volume down on the “news” front, ie consume less of it. You'd be better watching less of the financial soap opera in favour of episodes of The Brady Bunch or The Partridge Family.

• Third, adopt a long term strategy and stick to it. The environment we are now in has increased the importance of asset allocation – but this is best left to experts and those who can really put the time in to filter the noise from fundamental signals. Most individual investors will end up getting it wrong so the best approach is to agree a long term strategy and stick to it.

• Finally, recognise that the best opportunities in investing often arise when many are engulfed by gloom and doom and the market is cheap.

And just a thought on forecasting

For those who think I am being a bit harsh on the prognosticators of doom, I will be the first to admit I have had a few misses too. My first manager used to say "forecasting is hard because it concerns the future" which sounds inane but it’s fundamentally true. But the key is to maintain historical perspective, realise that yes bad things do happen, and that all experts can be wrong at times (including me!), but that most of the time things turn out okay for the economy and growth assets. I think it’s better backing that than the 20% or so chance that they won't.

Dr Shane Oliver
Head of Investment Strategy and Chief Economist
AMP Capital

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.

Key Points:

• After phasing down its quantitative easing (QE) program all year the US Fed has finally ended it. Monetary tightening still looks unlikely until mid-next year at the earliest and is contingent on further improvement in the economy and higher inflation.

• QE has worked – the US economy is now well into expansion mode and looking a lot stronger than Europe and Japan that have taken longer to adopt it.

• While the ending of QE could contribute more volatility to shares it has largely been anticipated. With the US likely to continue growing & monetary conditions expected to remain easy for some time to come the cyclical bull market in shares likely has further to go.

• The ending of US QE is also positive for Australia as it is a sign that the world’s biggest economy is better and removes a source of upwards pressure on the $A.

Download The end of US quantitative easing pdf 

I have long thought of the US Federal Reserve’s quantitative easing program (QE) as a bit like a drip keeping a patient in a coma alive until it can be brought out of the coma and survive on its own. The patient was the US economy post the GFC and the Fed was administering the drip. Quantitative easing involved the Fed using printed money to pump cash into the struggling US economy by buying up government bonds and mortgage backed securities. The first two rounds of QE ended prematurely in 2010 and 2011 before the US economy was ready to be taken off life support. However, having learned its lesson the phasing down of the latest round – commonly called QE3 – was made contingent on the economy strengthening. The Fed has concluded that this has happened so has been “tapering” its bond purchases all year and is now bringing them to an end.

But has QE worked? Was it worth the costs? What next? What does it mean for investment markets?

Has QE worked?

Quantitative easing sounds extraordinary – and in the context of the inflation prone world we all became used to it would have been. But given the deflationary shock delivered to the global economy from the GFC it is not. QE was needed to boost the supply of money in the US economy given the difficulties in pushing interest rates negative.

Quantitative easing helps the economy via: lower borrowing costs; more cash in the economy; forcing investors to take on more risks; and by boosting wealth, to the extent it drives shares higher, which boosts spending.

But has it worked? While there is much debate, at the end of the day the proof is in the pudding. And the evidence clearly suggests it has worked. While the US economy is still far from booming: growth has picked up pace; bank lending is strengthening; housing construction is recovering; consumer spending growth is reasonable; business investment is strengthening; business conditions are strong; employment is above its early 2008 high and unemployment has fallen to 5.9% (see the next chart); and deflation has been avoided.

Source: Bloomberg, AMP Capital

By contrast, the European Central Bank has dragged the chain on QE and so the Eurozone has unemployment stuck at 11.5% and inflation at just 0.3% is flirting with deflation.

Could the Fed be too early again?

In 2010 and 2011 the Fed was too quick to end QE. There is a risk now too. The global economic expansion is still uneven and US inflation is below the Fed’s 2% target. However, most US growth indicators are now in far better shape, so the risk is reduced. For example, compared to 2010 & 2011 unemployment is lower, employment is higher (previous chart) and consumer confidence and durable goods orders (a guide to investment) are higher (see next chart).

Source: Bloomberg, AMP Capital

But what about the costs – was it worth it?

Most of the arguments against doing QE don’t hold water:

• There has been no hyperinflation. US inflation is less than 2%. The mistake the hyperinflationists made was to confuse a surge in narrow money such as cash and bank reserves which rose with QE with a surge in broader money supply measures such as M2 and credit which hasn’t happened. And they ignored the spare capacity in US factories and in the labour market.

• Financial market distortions are relatively modest. Yes bond yields are low but this mainly reflects the reality of a long period of sub-par growth, low inflation and excess savings rather than distortions caused by the Fed’s holding of US bonds. And the forward price to earnings multiple on US shares at around 15 times is actually below its long term average and less than suggested by current bond yields. That said, maintaining easy money longer than need be does risk creating bubbles, but I doubt we are there yet.

• Currency wars. There was much concern in the emerging world that the $US would crash pushing emerging market currencies up or leading to uncontrollable capital inflows. In the event this was really much ado about nothing and more recently the argument has been run in reverse with some emerging market countries complaining the phasing down of US QE would cause capital outflows and a collapse in their currencies!

• Inequality in the US had been worsening long before QE. While it may be claimed that QE by boosting share prices accentuated inequality because more rich people hold shares, the alternative of allowing the economy to spiral on down and unemployment to surge would hardly have been good for equality. Moreover, other factors including technological innovation are arguably more important in explaining rising inequality in the US.

• The exit problem. This is the biggest risk. Given the lack of experience with quantitative easing there is a degree of unknown regarding the impact of exiting from it.

Much of the critique of the Fed has come from gold bugs and disciples of the Austrian school of economic thought that holds that periods of financial excess should be allowed to fully unwind to allow a proper cleansing of the system. As such they saw the Fed as interfering with the natural order of things and so foresaw dire consequences. The problem with this is that it ignores the role of free market forces in causing the problem in the first place and the likelihood that if free market forces are able to run their course numerous innocent bystanders would be adversely affected. This was what happened in the 1930s when US authorities stood by and allowed a 50% collapse in industrial production, the demise of hundreds of banks and 20% plus unemployment. Hardly a great outcome and hardly great for equality. So there is a case for monetary policy to smooth any adjustment in the economy, which of course is what QE has done. Knowing what the Fed knew about the risks around the GFC and the lessons of the 1930s they have done the right thing. To let the patient die (well not quite – but you know what I mean!) would have been morally indefensible.

What next?

If things go according to plan the next step is that the Fed will actually start to tighten. This will come in the form of raising interest rates and starting to reverse its QE program. It looks like it will primarily unwind its bond holdings by not replacing them as they mature, as opposed to actually selling them.

However, the Fed has made it clear that tightening is contingent on the economy continuing to improve and signs inflation is moving up to target. It has also continued to point out that it anticipates a “considerable time” to elapse before it starts to tighten. This reflects the fact that growth is still far from booming, labour force underutilisation remains, inflation on the Fed’s preferred measures is just 1.5% and inflation expectations have been falling. Our base case is the Fed will start raising rates and allowing maturing bonds to run down its bond holdings from around mid-2015. But if economic conditions are weaker than expected it could come later and a renewed round of quantitative easing cannot be ruled out.

What does the end of QE mean for shares?

Memories of the last two times when QE ended are fresh. After QE1 ended in March 2010 US, global and Australian shares fell around 15% and soon after QE2 ended in June 2011 shares fell around 20%. Fears of a re-run when QE3 ends have been one factor behind the recent roughly 10% correction in shares, so investors have partly pre-empted it.

Source: Bloomberg, AMP Capital

However, while the ending of QE3 may add to volatility it’s very different to the premature ending of QE1 and QE2, which occurred when the US was a lot weaker. Now the US economy is on a sounder footing. And while US QE has ended, it’s being replaced by QE in Japan and Europe.

It’s also worth noting that the rally in shares over the last five years is not just due to easy money. It has helped, but the rally has been underpinned by record profit levels in the US.

Source: Bloomberg, AMP Capital

Finally, it should be noted that US QE is ending because the economy is stronger, which is a positive for shares.

What about the impact on Australia?

The ending of US quantitative easing is a positive for Australia for two reasons. First, it’s another sign the US economy is on its feet again and a stronger US is good news for Australia as it means a stronger global economy. Second, it removes a source of upwards pressure on the $A, allowing it to continue its downtrend, once current oversold conditions are relieved, which will likely see it fall to around $US0.80 over the next year or so. This will help the Australian economy rebalance as the mining boom fades.

Concluding comments

With the US economy now on a sounder footing, the Fed is right to end its quantitative easing program. While this could contribute to short term volatility in shares, providing the US continues to grow as we think it will and given that we are a long way from tight monetary conditions the cyclical rally in shares that got underway back in 2011 is likely to continue.

Dr Shane Oliver
Head of Investment Strategy and Chief Economist
AMP Capital

 This video must be taken in its entirety and any given chapter viewed in isolation does not represent the entire message.

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.