The combination of softer confidence and weaker economic conditions will see investors continue to favour companies with an attractive dividend yield in the year ahead. Although this comes with capital risk, dividends provide an element of certainty.
A widening budget deficit and continued talk of the need for a weaker dollar are not conducive to promoting investor confidence in Australia. When it comes to market movements, confidence has proven to be a powerful force and often moves equity prices well away from their intrinsic value, distorting investment decisions.
A 7 per cent slide in the ASX 200 since October highs simply suggests the post-election bounce – on the assumption a change of government would be more favourable for business and the economy – was simply an illusion. A weakening in both business and consumer confidence has confirmed this.
The fallout from weaker confidence across the economy has the market anticipating both businesses and consumers will spend less, challenging earnings assumptions. From an investment perspective it could very well mean cyclicals won’t be revered like they were this year. Australia has underperformed international peers since October highs as other markets have posted gains over the same period. The Australian market can’t fall back on macro themes of taper talk and eurozone debt concerns – the year’s favourite justifications to explain a rough period.
In the opposing corner to confidence is actual economic rationale. That, theoretically, should support the market at current or higher levels. The record-low cash rate in combination with a steepening yield curve – the widening gap between short- and long-term rates – should act as favourable stimulants to the Australian market. This argument has no traction in the current market though as gains for the year are slowly given up.
While Glenn Stevens continues to argue Australia needs a lower exchange rate, it is difficult to quantify the actual effect this will have on the market. Yes, a weaker currency combined with the low cash rate should help interest rate-sensitive areas of the economy. But there is little evidence to confirm it is a given – investors could be holding out hope for something that will never arrive. A weaker currency could also disrupt other areas of the economy.
Even if confidence is weighing on the market, for domestic investors the market still offers a compelling investment thesis in light of low interest rate alternatives.