All Ords Report 01 February 2017

Borrowers in a low interest rate environment are blissfully unaware of what lies ahead.

Many Australians are back at work after their holidays. The tennis and the ‘Big Bash’ cricket are over, so are Chinese New Year celebrations. Perhaps you are grappling with getting the kids back into the usual routine for school?

Unless you had a ‘big’ holiday or went on a spending spree over Christmas, your financial situation may not be front of mind. However, it’s time to starting thinking ahead as interest rates may start to rise at the end of the year, and this impacts anyone with a loan.

Banks can also move rates outside of the Reserve Bank’s change to the cash rate. Lending rates for investment loans have already moved up. It may seem early in the year, however, before life really speeds up again and you feel like you’re on the treadmill, now’s the time to start planning for the "what-ifs".

What if the Reserve Bank of Australia (RBA) start increasing the cash rate towards the end of the year? Many analysts suggest that in light of the current economic data an earlier intervention would not be warranted, and is therefore unlikely, however are analysts always right?

The RBA will be watching inflation data closely. Economists would like to see the inflation rate back above 2 per cent. Historically the RBA has a policy of maintaining inflation between 2 and 3 per cent.

That said, if the price of oil starts to rise swiftly this year, and the analysis indicates it may, we will see upward pressure on inflation. Of course, other related measures such as a lift in consumption growth, seen in December, has allayed concerns that consumption may be slowing significantly.

More importantly, if the cash rate does rise at the end of the year by 0.5 per cent, and therefore borrowing rates rise by this amount, would this put you or a family member under pressure financially?

What if the banks hike rates out of turn with an RBA rise? What if you lose your job, or are injured and cannot work, or suffer an illness? That’s bad enough, without your interest expenses going up. A reality check like that would really make you stop and think.

So why get caught out, when you have choices that prepare you for the “what-ifs”. Consider income protection insurance, or perhaps working out how much you can set aside each week to build yourself a cash buffer. Also, investigate how you can create another income stream. The key is really about being proactive rather than reactive.

What do we expect in the market?

The Australian share market has pulled back over the past three weeks to around 5660 points. Prior to the next rise, I would like to see the market come back to between 5500 and 5600 points to provide support for a sustainable rise over the medium term. Currently, the analysis indicates this is likely in the coming weeks.

So far the All Ordinaries Index (XAO) has fallen by around 3.7 per cent from the high in January of 5876.8 points. The analysis still indicates that a rise above this high is likely in the short to medium term, and the medium term target is between 6200 to 6400 points. However, a shorter pull back on the market than I mentioned above may result in a shorter rise, to around 6150 points.

Some of the broader issues

You may have heard commentary recently that share prices must fall to create value. This you will hear in every business cycle regardless of whether economic conditions differ slightly, which is why a chart of the XAO can really put some perspective around the commentary.

Remember also, company fundamentals alone don’t drive the market. Perception and social mood is another major contributor to what you can see unfold on a chart. And, patterns repeat over time. Recently, I have heard analysts from major broking houses saying how they convey messages will be important in managing the expectations of investors.

In my opinion, the market is unlikely to get too far ahead of itself right now, however, there is still a lot of money waiting on the sidelines to drive it higher. Generally, markets will factor into the prices of shares information and events, six months in advance - that is a healthy, ‘normal’ market.

However, from a global perspective, there are a lot of mixed messages about the impact to growth from president Trump’s policies and this is not presently well understood, which means you have to expect some short term volatility for shares. This goes hand in hand with investing. That said volatility in a ‘normal’ market is a good thing as the market has to move up and down along the overall rise to achieve greater heights.

This reporting season in Australia, market players are looking for Australian companies to at least meet earnings expectations, or be able to demonstrate a positive outlook, which will be a challenge for some, particularly those who may be impacted by a change to US policy.

Remember too, analysts have been conditioned over the past few years to factor in a ‘lower’ growth environment, and it shows, the Australian market has been trading sideways for a few years, which really means we are likely to see a further rise on the market this year.

Dale Gillham is Chief Analyst at Wealth Within