Bull market has hit hurdles

Investing in 2018 – the new normal


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After a strong 2017, conditions going forward may be more challenging at the macroeconomic level.

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Boh Burima

Boh Burima

Stock investors have enjoyed an extended bull market since March 2009. It was particularly enjoyable during 2017, when the ASX 200 accumulation index rose by 11.8 per cent over the year.

Such an impressive return is quite extraordinary for an ageing bull market going on nine years in 2018. The music seemed to stop abruptly when the S&P 500 plunged 10.2pc over 13 days from late January through early February; however, our market fared much better given we had missed most of the US January rally. 

Although equities have recovered somewhat since, the episode is a reminder that expensive equity, bond, and bond-proxy prices are at risk from the end of ultra-low cash and bond yields. Prices for bonds and equities are at, or near, record levels due to the ultra-low policy interest rates and the massive quantitative-easing programs of the major central banks (the US Federal Reserve, the European Central Bank and the Bank of Japan) over the past decade.

But now two of those central banks are winding back. In response to the strengthening economic environment, the Federal Reserve is raising the cash rate and has started an automatic program to shrink its balance sheet while the European Central Bank has halved its asset-buying program. 

While the major central banks would like us to believe that they will normalise interest rates with minimal disruption to asset pricing, there is a material risk that they could be forced to tighten monetary policy faster than expected as inflation re-emerges.

The potential for the US administration’s tax cuts and recent budget measures have elevated the risks. The tax cuts and additional spending will make a fiscal injection into the US economy of nearly 2pc of GDP per annum for the next two years. 

The timing of such a large fiscal stimulus near the top of an economic cycle when central banks are trying to exit the largest monetary expansion in modern history may prove to be the tipping point for higher than expected policy rates. 

If this plays out, valuations will be negatively impacted and episodes such as the one we witnessed late January and early February will likely be repeated. We have been particularly wary for some time of overpaying for growth in a low inflation environment and see risk that valuations will revert towards the long-run average.

There’s no doubt after a strong 2017, conditions going forward may be more challenging at the macroeconomic level and we remind investors to remain vigilant. 

Despite the return of volatility, solid returns are still possible in this environment and we highlight some themes and stock ideas we think will provide positive returns for investors over the course of 2018. 

Reflation – A reflationary environment that comes from economic growth would be positive for financials from leverage to rising interest rates and credit growth. Resources will benefit from improving raw material demand and commodity prices. Our key exposures are Westpac, Suncorp. 

Global Recovery – Company earnings for the MSCI All Country World Index are estimated by Bloomberg to grow by 18pc this year. This compares to the ASX, which is set to grow at a more modest 7pc. Therefore offshore revenue earners are better placed to benefit. Our preferred offshore exposures include Corporate Travel Management, Macquarie Atlas Roads, and Apollo Tourism and Leisure. 

Mergers & Acquisitions – An improving economic backdrop, higher earnings certainty and low borrowing costs make acquiring growth an attractive option. Healthcare and resources have already seen their fair share of deal activity. We expect activity to scale up if conditions remain supportive. Companies in the box seat include the large miners with solid balance sheets. 

  • Boh Burima, Financial Adviser (Authorised Representative: 000341081) Morgans Financial Limited | ABN 49 010 669 726 | AFSL 235410 
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