Markets rallied in November, welcoming the victory of Donald Trump and the Republican Party in gaining control of the US Presidency and Congress. President-elect Trump has pledged to pursue a plethora of economic and trade policies, including:
- Mass deportation of undocumented migrants.
Whether these election promises will be enacted is unknown, however, markets are concerned about possible consequences, such as the potential inflationary impact, rising debt levels, the strong US dollar, and expected tightening in labour markets.
All suggest risks of more volatile inflation, a slowing in the reduction of official interest rates, US public debt surging past 100% of GDP, and a return to excessive risk-taking in markets. Perhaps the so-called “bond vigilantes” will constrain some of these policy initiatives. Nevertheless, whatever the concerns, most markets strongly endorsed the forthcoming change in the US Administration.
In the US, share market indexes ended November up, with the benchmark S&P 500 +5.73%, the Dow Jones +7.54%, and the Nasdaq +6.84%. Other global markets were mostly stronger: Germany’s DAX was up 2.88%, Britain’s FTSE was up 2.18%, and China’s key index rose slightly following falls the previous month. The French CAC fell -1.57% after experiencing further political ructions and a sharp sell-off in French government bonds. Japan’s Nikkei was -2.22% lower.
The ASX 200 rose in November, with Technology the best sector, followed by Financials. Resources were the worst performing sector, especially Gold as the market reacted to Trump’s win by pushing up bond yields and the US Dollar (USD). That said, Resources have been poor performers for the last two months, retracing much of the China stimulus rally. BHP rallied 15% in 5 days in late September but has since retraced over 80% of this move, including a near 6% decline in November. Banks stand out as having risen substantially over the last 12 months.
The ASX 200 is up over 20% over the last year. Valuations for Australian stocks are stretched, with the forward price-earnings ratio (fPE) around 18.5x versus a long-term average of 14.5x. Looking at broad indexes hides the wide variations between sectors: for example, Health is trading on a consensus forward PE of 32x, Consumer Discretionary at 25x, and Financials and Real Estate at 19x, whereas Energy is trading at 12x and Materials at 13x.
Are ASX valuations stretched?
Over the long term – say 25 years, the Australian market has traded on a fPE of around 14.5x. Over the last 10 years, the market has traded at a slightly higher multiple of around 15.5x, reflecting in part the very low interest rates over much of that period. More recently, the fPE of the market has stretched to 18.5x, somewhat expensive compared to historical patterns.
It should be noted that the fPE is looking at next year’s forecast earnings – those forecasts could be wrong, or indeed the market might be looking beyond next year and seeing value further down the track and be prepared to pay up for those better prospects. Unfortunately, the consensus outlook for strong earnings growth is largely absent from the Australian market at present. Forward PEs are simply one measure of assessing value and by no means foolproof.
The AUD closed the month at a touch below USD 0.65 and has fallen from a high of USD 0.69 at the end of September. While partly a reflection of sluggish commodity prices, AUD weakness largely reflects USD strength.
President-elect Trump says he prefers a weaker USD but as noted above, economists and investors think his proposed policies will have the opposite effect. Since his election victory, the greenback has been rising. Even though the value of the USD is largely set by domestic developments in America, its reserve currency status means its movements ripple across the globe. Further big movements in the currency may be around the corner as policies spoken about by Trump on the campaign trail are implemented.
A rising USD often comes hand in hand with a weakening global economic outlook. One reason for this is that during times of economic turmoil, investors tend to sell off their risky assets and move into “safe havens”, notably the USD and American Treasuries. Whether a strong USD lasts remains to be seen. Donald Trump has complained that a strong greenback hurts domestic manufacturers and costs American jobs. But he cannot force the US Federal Reserve (Fed) to cut rates, and if rates stay fairly high, America’s currency will probably remain a refuge for many international investors.
Germany’s economic decline
During October, Germany’s GDP numbers were disclosed as being in negative territory. German output contracted last year as high inflation, rising interest rates, and elevated energy costs made Europe’s largest economy one of the weakest performers in the world.
Overall economic development faltered in Germany in 2023 and over the first half of 2024 in an environment that continues to be marked by multiple crises. Unlike countries like the US, the German economy did not continue its recovery from the sharp economic slump experienced in the pandemic year of 2020, although Germany’s GDP was 0.7% higher in 2023 than in 2019, the year before the COVID-19 pandemic hit.
Indeed, Germany was the worst-performing major economy in the world last year, according to the IMF, underlining how Germany’s export-focused manufacturing sector has been hit by the loss of cheap Russian energy and the slowdown in demand from China.
China – stimulus amidst tariff tensions
After much anticipation, China’s government announced details of its fiscal plans. The government said it would issue about $1.4 trillion of additional government bonds over three years to repay local governments’ off-balance-sheet debts. This is in line with figures announced in October but fell short of hopes. Officials said other initiatives, such as a major recapitalisation of the largest state-owned commercial banks, remain in the works. China’s pivot to stimulus is unfolding as a series of measures rolled out over several months, rather than a single make-or-break event.
The latest stimulus package is their biggest fiscal package in recent years, and the latest effort to jump-start economic growth as the Chinese government battles trade tensions and the threat of sweeping new tariffs from Donald Trump.
The fact that China appears to be preparing for a trade war and keeping some of its stimulatory plans in the bottom draw ahead of that battle, is a worry for Australia. UBS estimates that US tariffs on China could slice 1.5% to 1.75% off GDP growth. Stimulus could offset this, but the hit to the Chinese economy – and the demand for key Australian exports such as iron ore and coal – may be significant. Treasurer Jim Chalmers said, “We wouldn’t be immune from escalating trade tensions that might ensue.”
Prices of iron ore and copper, materials used in construction, declined on the expectation of lower demand in China, where the property market crisis has been dragging on growth for years.
It is no surprise that commodity prices, and resource stocks, have been under pressure.
As we have noted previously, prudence suggests that positive sentiment is stretched, valuations are high, geopolitical/economic risks are elevated, and uncertainty around policy and politics, as the new US administration takes control, is growing. We think that a defensive stance remains sensible, even as positive market momentum appears to be the path of least resistance.
Key trends shaping the year ahead
Some notable trends from this year are expected to continue influencing the year ahead:
- Inflation has peaked and is now falling in a steady trajectory.
- Cash interest rates are being adjusted down by central banks. The Reserve Bank of Australia will follow next year.
- Global economic growth is moderate, and no world recession is likely.
- The USD and gold have been strong, and the AUD and crude oil weak.
- Share market valuations are generally expensive.
- The US economy is growing in a robust fashion while Australia’s economy remains subdued.
- Bond markets are at risk from highly elevated debt levels in many developed economies.
