Clouds gather over the market

Investors face a tense month ahead, with the challenges of fiscal austerity at home and geopolitical uncertainty abroad.

With May upon us and the clouds building, it’s worth revisiting a couple of the major headwinds facing markets and what they might mean for performance over the next few months.

Federal budget

Ahead of the May 13 federal budget, the first for the current government, there was always going to be a period of uncertainty. However, the government’s recently proposed ‘debt levy’ seems to have taken this uncertainty to a new level.

What we do know is that since the debt levy was flagged on April 28, the S&P/ASX 200 index is down approximately 2.2 per cent. Perhaps tellingly, the weakness has been led by the big four banks and consumer discretionary stocks.

Put simply, the proposed debt levy came as a huge surprise -- and markets hate surprises. While investors knew there had to be significant spending cuts to reduce the deficit, they were completely blindsided by the prospects of a tax hike, or debt levy if you prefer the political spin. This is especially the case when considering the election promise of no tax increases.

While we could go on for hours about the probable effects on our economy and stock market, the recent weakness probably tells us enough. Consumers’ disposable income is going to be hit, in turn hurting consumer spending and confidence and rippling further out through the domestic economy.

However, in all likelihood the government is probably deliberately preparing the public for the worst so the eventual budget doesn’t feel so bad. Only time will tell.

Ukraine

The rapid escalation in tensions between Russia and the Ukraine continue to add significant uncertainty to the global geopolitical and macroeconomic backdrop. The crisis is quickly morphing into a global issue as it threatens the slow recovery in Europe and potentially wipe billions of dollars from the bottom line of multinational companies.

The impact of the conflict on the Russian economy has already been felt as stiff sanctions take grip. The stock market is down 20 per cent year-to-date and the International Monetary Fund (IMF) recently downgraded Russia’s 2014 GDP growth forecast to 0.2 per cent from 1.3 per cent.

From a European and global perspective, the real problem starts when local tensions significantly impact commodity markets. With one- third of Europe’s gas flowing from Russia, it is easy to see how a significant supply disruption would send energy prices rocketing. This in turn would see Europe’s already fragile recovery having to contend with high energy costs.

Outside of these two major headwinds, we are continuing to see weakness from China, which was further confirmed by this week’s weaker-than-expected HSBC PMI figure. These growth concerns, coupled with recent media attention on Chinese property prices, are likely to continue to cloud the outlook for Australian equities, especially the resources sector.

Nonetheless, we still believe we are in a long-term bull market. Assuming markets do as expected and pullback in the near-term, we would recommend using share price weakness as a strategic buying opportunity, with sustainable large cap yield plays likely to be in focus.

Ben Potter is Retail Editor at Baillieu Holst Ltd.

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