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The way forward

The Australian equity market’s rough ride has continued into May with the S&P/ASX 200 Index trading in a wide 450-point range over the past four weeks.

Business & finance

The way forward

Policy stimulus in the form of interest rate cuts, central bank programs and government rescue packages have been aggressive and, so far, have reduced the risks of a credit crisis developing.

The Australian equity market’s rough ride has continued into May with the S&P/ASX 200 Index trading in a wide 450-point range over the past four weeks.

Adding to the volatility, more than half of daily moves in that period have been one per cent or more.

Policy stimulus in the form of interest rate cuts, central bank programs and government rescue packages have been aggressive and, so far, have reduced the risks of a credit crisis developing.

Moreover, the sharp de-rating in stock markets has seen price-earnings premiums to long-term averages virtually evaporate.

Also important is time – in our view, most of the drivers of the latest downturn will be temporary rather than prolonged, allowing economies to emerge from the worst of the damage inflicted by the coronavirus (COVID-19) relatively quickly.

That said, a full return to health will likely take several years, as evidenced in the latest economic growth forecasts from the Reserve Bank of Australia (RBA), which envisage a steep contraction of the economy in the rest of calendar year 2020 before a rebound in calendar year 2021.

The RBA expects gross domestic product to shrink by eight per cent in the June quarter of 2020 before returning to growth of seven per cent in the June quarter of calendar year 2021, and then moderating to five per cent growth in June 2022.

The central bank’s two key measures – unemployment and core inflation – however, will remain out of reach for some time.

As of June 2022 – the bank’s forecast horizon – the RBA estimates the unemployment rate will still be 6.5 per cent (after peaking at 10 per cent in the June quarter of 2020), well short of its 4.5 per cent target. Meanwhile, core inflation in June 2022 is projected to be only 1.5 per cent (after bottoming at 1.25 per cent over the June quarter 2020 to December quarter 2021 period), also well short of the bank’s 2.5 per cent target.

Nevertheless, policy stimulus and growing confidence that the spread of COVID-19 is being managed have allowed equity markets to bounce back from their lows.

Authorities will not expect to see COVID-19 eliminated; rather, they want to control the spread, and on this front, the good news continues.

As further stimulus measures actually take effect – JobKeeper payments, for example, only started to land in people’s pockets in May – and cushion the economic impact, we can see the S&P/ASX 200 Index returning to a 5500-6000 level by the end of this year and see scope for the Australian equity market to then start outperforming.

We are not as confident on the upside for US equities yet, given they have outperformed in the year to date – the tech-heavy NASDAQ Composite Index is now actually slightly firmer in calendar year 2020.

Furthermore, we see the currency being less of a benefit to US dollar investments, given we forecast the Australian-US dollar exchange rate staying around $US0.65 this year.

Troy Davey is an Authorised Representative (no 473122) of Ord Minnett Ltd, AFS licence 237121. He can be contacted on 5430 4444. This article contains general financial advice only and does not consider your personal circumstances; you should determine its suitability to you and consult a financial adviser and consider the relevant product disclosure statement before purchasing a financial product. Past performance is not a reliable indicator of future performance.

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