Economic recovery drives gains for Australian share market

Rapid economic recovery and low interest rates drove strong gains for the Australian share market in the last quarter.

Growth assets finished the financial year with strong gains, due to a recovery from the market lows of a year ago, which were triggered by the COVID-19 outbreak.

Since then, central banks have lowered interest rates to near zero, while governments have provided massive fiscal support.

In addition, several COVID-19 vaccines have been developed and are being distributed globally.

The global economy has been experiencing some recovery from the 2020 lows, with the International Monetary Fund (IMF) forecasting 6 per cent growth in 2021 and 4.4 per cent growth in 2022. However, the recovery remains uneven, with COVID-19 outbreaks still causing lockdowns in various countries, including Australia, and vaccination rates varying wildly across the world.

In Australia, the economic recovery has been stronger than expected, with the Reserve Bank of Australia (RBA) expecting growth of 4.75 per cent in 2021 and the unemployment rate to fall below 5 per cent.

Fiscal and monetary policy remains very accommodative, and strength in commodity prices is also supportive. However, COVID-19 outbreaks continue to disrupt the recovery, particularly in Victoria and New South Wales, but have been typically short-lived.

The Australian share market finished the financial year with a strong gain of 27.8 per cent, which was mostly driven by the financial (+40.6 per cent) and material (+34.5 per cent) sectors, which together represent more than 50 per cent of the S&P/ASX 200 index (financials represent about 30 per cent of the index and materials represent about 21 per cent).

Banks staged a sharp rally from their lows, as low interest rates led to a recovery in the economy and lending volumes, while also reducing the threat of loan impairments. Resource stocks also recovered on buoyant commodity prices.

Moving forward, we expect the rally in banks and resources to level out, and for other sectors to outperform.

The main short-term risk continues to be around COVID-19 outbreaks, which recently resulted in Victoria and New South Wales entering extended lockdowns. However, this has led to renewed focus on vaccination and quarantine procedures, which should be positive in the long-term.

Generally, the outlook remains positive for growth assets (equities, property, and infrastructure), on the prospect of economic growth rebounding and having accommodative fiscal and monetary policy. However, the possibility of rising inflation and interest rates remains the key risk to bond and equity markets.

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