The Aussie equities market in 2017 can be grouped into three distinct periods: 1) the Trump trade; 2) the Range trade; and 3) the Goldilocks trade.
The Trump trade carried into the year the reflation theme of 2016, driving the ASX 200 Banks Index 5.6 per cent higher in Q1 as expectations of higher inflation and growth fuelled a cyclical recovery. This optimism soon faded, with President Trump’s policy reforms hitting roadblocks in Congress, falling bond yields and uncertainty leading the market sideways through mid-year. In the back half of the year global economic uncertainty eased and volatility all but disappeared, and the growth without inflation environment or ‘Goldilocks trade’ buoyed markets. Aussie shares are on track to deliver a 10.5pc total return for 2017, which is only a touch below the 25-year average.
Outlook for 2018
Markets remain in a sweet spot as we look ahead into 2018, with global growth becoming entrenched and inflation still conspicuously absent. We expect interest rates to rise, but slowly, leaving businesses with a decent backdrop to work with and healthy growth puts the world in a better position to deal with the next downturn. This remains an equities friendly environment, with offshore jurisdictions still looking relatively more attractive to the more subdued economic growth in Australia.
However, we caution against investor complacency in this environment. A key question for 2018 is whether investors will continue to shrug off geopolitical risks including escalation of tensions in North Korea, increased trade protectionism and the future of the EU. Furthermore, higher interest rates usually signal a close to a bull market, so investors should be prepared for a return to more normal levels of market volatility, and remain focused on nimble stock-picking around these events.
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Solid returns are still achievable in this market; however, these should not come at the expense of investors taking on excessive levels of risk. A number of geopolitical risks could affect trade and market stability in 2018, including UK talks to leave the EU, political instability in Washington, tensions over North Korea and increased trade protectionism.
While we don’t see a need to be alarmed at this stage, investors should be prepared for at least some potential for an escalation of these risks. Leaving some cash on the sidelines is prudent at a time where significant risks stand on the doorstep.
In 2013 the mere hint that the US Fed would end its unprecedented economic stimulus caused investors to throw a ‘taper tantrum’ devastating Emerging Markets. Markets are currently pricing in a slower pace of interest rate rises and taking each increase in its stride. But this could all change if inflation surprises off very low expectations.
Unemployment rates around the globe have fallen, with the US sitting close to full employment while capacity utilisation is back at pre-GFC levels. Higher interest rates usually signal a close to a bull market, so investors should be prepared for a return to more normal levels of market volatility.
The underperformance of Aussie equities versus global peers reflects an economy that has failed to break decisively out of its post-mining slump. Low growth and low rates have made investing for yield a profitable strategy for much of the post-GFC period. However, we are starting to see limits to this strategy as rates flatten out and threaten to rise, particularly as Industrials (ex-Financials) earnings per share growth of 4-7pc remains well below average. Our market may continue to lag global peers until we get a clearer read on a genuine acceleration in the economy.
- Boh Burima, Financial Adviser (Authorised Representative: 000341081) Morgans Financial Limited | ABN 49 010 669 726 | AFSL 235410