As we begin another drama-filled week on the global stage, a leading Australian investment manager has encouraged investors to stay optimistic as market driving forces will more likely move to avert risk rather than allow for recession.
Jamie Nicol, chief investment officer at DNR Capital, says the market has been too fast to price in a US recession as the Federal Reserve is unlikely to sit on its hands in the face of economic downturn.
“Looking forward, the market has priced a potential slowdown very quickly despite a number of indicators remaining positive, such as manufacturing data and capex expectations. It is not a fait accompli that the US Federal Reserve will sit back while the US market rolls into a recession.”
Macro-events to look to this week
Despite tensions ramping up between the US and China over the detainment of Huawei CFO Meng Wanzhou and the potential of a hard Brexit confronted this Wednesday, he said it was important for investors to consider the range of outcomes as the market forces will likely seek to avoid risk.
“Considering what can break the current cycle of risk aversion, we look at a range of possibilities,” he said.
“Firstly, the US Federal Reserve chief has suggested US interest rates are near neutral, which suggests the pace of change will ease – a pause in interest rate rises would ease fears of further tightening.
“Secondly, the US and China have agreed to a cease fire in the trade wars, which provides some further breathing space for China and emerging markets. Further progress on this agreement would also be helpful.
“Thirdly, while challenging, resolution of Brexit would provide additional certainty.
“And lastly, the RBA deputy governor last week flagged for the first time the potential for rate cuts in Australia.
Market forces will move to avoid risk
“While these only remain possibilities at this stage, it is important, when the market is becoming very risk averse, to avoid seeking out the bad news (which the market is inclined to do in this environment).”
He said that although valuations have been high of late, pullback in the market has somewhat alleviated this risk, while bearish investor sentiment should be taken as a good sign that recession is not on the horizon.
“While we think the market has been quick to price in a recessionary risk despite mixed evidence, valuations have been high this cycle (driven up by low interest rates) and justified a de-rating,” he said.
“Following the pullback, valuations are more reasonable especially when compared to interest rates and bond yields. Earnings growth expectations in Australia appear modest with some small downside risk if housing deteriorates further (an RBA cut would be helpful).”
“Also following the pullback in the market, sentiment seems reasonably bearish or cautious — generally a positive indicator, albeit there has not been outright panic.”