Shares rally but deflation threat looms

Global markets rally

Global markets have delivered solid gains after the Brexit vote. Factors driving the strength in shares have been fairly consistent. Economic data have been respectable and June quarter corporate profits in the US have been well up on the previous quarter.

In addition, central banks have delivered a broadly consistent message of easy monetary policy, supporting improved investor sentiment.

Global market outlook

The Brexit decision helped clear much of the concern overhanging global shares and fuel the recent rally. However, the rally has left shares slightly overbought from a technical perspective. Given that August and September are traditionally more difficult months for shares due to seasonal factors, markets could undergo some consolidation in the short term.

But looking further out, it's reasonable to expect increases in share prices over the next six to 12 months, given the global economy is still growing and interest rates are very low. The combination should flow through to stronger company profits.

Australian economy solid despite the end of mining boom

The Australian economy is doing reasonably well. We've been growing at a pace of about 3% which is far stronger than most other developed economies. The end of our mining boom brought on a fair bit of doom and gloom, with widespread expectations that Australia would slide into recession.

However, that hasn't happened. Why? Mainly, it's because interest rates have fallen and partly reflect that the Australian dollar has come down. Taken together, these two factors have helped those parts of the economy that were struggling through the course of the mining investment boom. In addition, we are going through the third and final phase of the mining boom, which is the export volumes that come out of the completed resource projects.

Outlook for the remainder of the year

Although Australia’s economy is growing faster than most other developed economies, our inflation rate remains too low for comfort. In late July, inflation slid to a 17-year low of an annual 1%. The Reserve Bank of Australia (RBA) worries that if inflation remains at these low levels, it will become entrenched. If we get a downturn at some stage, that could tip us into deflation. So, the RBA has cut interest rates a few times this year.

We expect to see another rate cut to come, probably in November. Besides attempting to spur inflation from its chronically low levels, the RBA is also conscious that interest rates in the rest of the world are near zero. That puts upward pressure on the value of the Australian dollar. If the RBA does nothing to combat that, the Australian dollar will keep rising, creating difficulty for our economy.

In summary, the Australian economy is doing well but inflation is low. Because of the low inflation rate, the RBA can be expected to cut rates at least once more in coming months.

Source: AMP Capital

Shane Oliver

Dr Shane Oliver has extensive experience analysing economic and investment cycles and how current positioning affects the return potential for asset classes such as shares, bonds, property and infrastructure. Shane is a regular media commentator, providing economic forecasts and analysis of key variables and issues that affect all asset markets.

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.