The Australian sharemarket rose strongly on Friday, breaking a run of almost continuous daily falls since late May. While it is too early to say whether the gloom from May has started to go away, there are good reasons in our view why risk assets should rebound over coming months. The most important reason is that the global and local growth outlook appears to be stabilizing. Moreover the growth outlook looks set for a long, moderate, sustainable improvement.

In the US, in particular, evidence is mounting that the economy has entered a phase of sustainable improvement. Rising household wealth on the best lift in house prices since 2006 and a 4-year rally in the sharemarket, combined with rising employment and household income and a much reduced household debt burden have placed US consumers in a strong position to lift spending even in the face of higher taxes. In mid-June, consumer sentiment at 82.7 is running close to the recovery high 84.5 reported for end-May.

In addition, US companies are reporting record profits and even the US banking sector at the heart of the global financial crisis back in 2008 has substantially recapitalized, returned to profitability and started to lend. The government sector in the US is showing signs of improvement too, notably at local and state level, where finances have improved to the point where employment has stopped falling.

Good news on the US economy, however, is being treated as if it is bad news because it may mean the US Federal Reserve (Fed) starts to reduce its liquidity support (monthly $US85 billion bond purchases) placing upward pressure on US interest rates. The two-day Fed policy meeting this week is particularly important in this regard providing the opportunity for the Fed to make clear its position, namely a recovering US economy is good news and it will work to ensure that it is treated as good news by only starting to taper liquidity support once the economy is a good deal stronger than it is currently and will be flexible enough to change position if any signs appear that growth could falter.

In Australia too, there are signs that the market has become too negative about growth prospects. Over the past week, data reports showed a fourth consecutive monthly increase in April in housing finance commitment for owner occupiers a sign that housing recovery is well under way. Business sentiment stabilized in June according to the monthly NAB survey and the consumer sentiment rebounded by 4.7% according to the Westpac-MI survey. Back to official data and employment confounded market expectations of a fall in May and rose by 1,100, while the unemployment rate edged down to 5.5% (the market consensus forecast was 5.6%). All of these readings are consistent with an economy able to grow quite well, even with a sizeable pull-back in mining investment spending.

The market, however, remains fixated on negatives – cutbacks in mining investment, job losses in manufacturing and the finance sector and a still long wait to the mid-September election for greater certainty on Federal government policy. Meanwhile positives are ignored – housing activity is in the early stages of a recovery phase, especially in New South Wales. Several big employing sectors – education; health; wholesale trade; transport, postal and warehousing; accommodation and food services; and professional, scientific and technical services have added jobs in the year to February 2013 at very rapid growth rates ranging 3.4% y-o-y to 16.5% y-o-y and between them added 315,500 jobs in 12 months. Manufacturing and finance combined lost 40,700 jobs over the same period. The falling Australian dollar is becoming a plus for growth. Sustainably low borrowing interest rates are another plus. On balance, the local economic news is relatively good and looks set to get better, good reason to regard the recent falls in risk assets as a temporary correction. Also good reason not to become too excited about the prospect of further RBA cash rate cuts.