By Jeff Mitchell, Head of Investment Research, Australian Unity Personal Financial Services

2017 was another solid year for investment returns with stock markets around the world generally moving higher.

Synchronous global growth was somewhat of a catchphrase for 2017 with global economic growth accelerating for the first time since 2014. Economic growth looks set to accelerate further in 2018.

This should provide a positive tailwind to company earnings and valuations. However, as global economic growth accelerates the risk of inflation rising also increases.

Unemployment has generally trended lower globally which is also a positive for the global economic picture. However, there are signs of wages growth pressure emerging around the globe.

Geopolitical risks are almost always present in financial markets and, despite 2018 looking like a year of healthy positive sharemarket returns and low volatility, investors should remain alert to these events. They possibly include:

• The Trump presidency continuing to polarise opinion
• The ongoing tensions in the Korean Peninsula as North Korea continues to demonstrate its nuclear development with missile tests
• Trade tensions between China and US – if the relationship becomes strained resulting in embargos and various other forms of protectionism, there is potential for China to sell their investments in US government bonds which would likely result in volatility in pricing of not only US bonds but many other assets around the globe.

Australian sharemarket to continue positive trend

Australia’s S&P/ASX 200 Accumulation Index gained 11.8% during 2017, and the Small Ordinaries Accumulation Index gained 20%.

Poorer performing sectors of the Australian sharemarket over the past year included Telecommunications (-26.0%), Retail (-16.6%) and Financials (-0.2%). On the other hand, better performing sectors included Healthcare (+23.6%), Information Technology (+23.2%) and Metals and Mining (+22.3%).

The outlook for Australian shares in 2018 appears reasonable with yields remaining attractive relative to a benign cash rate. However, valuations do not appear cheap at current levels with the market requiring new leadership to drive earnings and prices sustainably higher.

New company listings on the stock market will be something investors should monitor closely for investment opportunities.

In 2018, we believe that demand for Australia’s commodities will be underpinned by China’s resilient economic growth combined with accelerating economic growth in many other economies.  And, given the focus by major mining companies on capital discipline and a lack of large green-fields developments in most commodities, there is potential for sustained price increases over the next few years.

The banking sector will be under the spotlight during 2018 with the Federal Government announcing a Royal Commission into Banks and Financial Services.

Australian residential property is likely to continue softening

The Australian residential property sector will be watched closely given the sustained rises achieved over the past few years.

There are, however, signs of a softening in parts of this market, most notably in Sydney and Melbourne, as foreign buyer interest appearing to have peaked, interest-only loans to investors have been re-priced by banks and increased regulatory focus on the mortgage market with the regulator tightening reporting standards for the banks.

Australian listed property (REITS) will be patchy

Australian listed property returns in 2017 were modest (5.7%) with the outlook varied amongst the different sectors of the market.

In 2018, supply constraints in both Melbourne and Sydney CBD office space should buoy rental increases whilst retail-focused REITS may find the environment increasingly challenging with Amazon’s Australian business now up and running with yet another threat to domestic “bricks and mortar” retailers.

Australian Fixed Interest – low rates to stay

Our base case remains that interest rates will remain below their historical averages for the foreseeable future.

However, we are now at a point where the nadir in interest rates may have been seen in a number of different countries. Central bank policy around the world will continue to be monitored closely by investors as policy-makers begin to raise official interest rates and unwind quantitative easing as economic growth becomes self-sustaining, unemployment falls and inflationary pressures start to build.

At this stage expectations are that the Reserve Bank of Australia won’t increase rates during the first half of 2018 and it is increasingly likely no rate rise may occur at all in 2018.

On the other hand, expectations are the US Federal Reserve will raise the Fed Funds rate an additional three times during 2018.

The US sharemarket looks over-valued

The US economy and stock market continued to strengthen during 2017. The S&P500 total return index gained 21.8% while the Dow Jones Industrial Average gained 25.1% and the NASDAQ Composite gained 28.2%. The so-called FANG stocks, Facebook, Amazon, Netflix and Google (now known as Alphabet) were again strong gainers during 2017. Facebook, Amazon and Netflix each posted gains in excess of 50% for the year with Alphabet posting a 32.9% gain.

The US economy grew at an annualised rate of 3.2% in the September quarter, marking the first time since 2014 it had achieved more than two consecutive quarters of GDP growth above 3%.

Unemployment in the US has also fallen and now sits at just 4.1%. The US economy should be buoyed further in 2018 as personal and corporate tax cuts further stimulate the economy along with bolstered expenditure on infrastructure.

However, the US sharemarket faces a number of risks moving into 2018. Firstly, by our reckoning, it has moved into the ‘over-valued’ phase and as such may be due for a correction.

In addition:

• A trade war between China and the US cannot be dismissed with President Trump a vocal critic of trade relations between the two countries.
• Inflation accelerating is a risk to the US bond market given how low interest rates are. If bond yields move markedly higher this will inevitably impact other asset classes such as equities.
• A US government shutdown is possible if agreement in the US House of Representatives between Republicans and Democrats cannot be reached. This would be the first time since 2013 a shutdown has occurred and would result in the temporary closure of some government agencies until budgetary funding is agreed upon.

European share markets to continue their recovery

European share markets generally had a solid 2017, underpinned by strong economic growth. Germany’s DAX index gained 12.5% in Euros, France’s CAC40 gained 9.3% and the United Kingdom’s FTSE100 gained 7.6% (denominated in British Pounds).

In 2018, we believe that European share markets can continue to gain as European economies continue their recovery and global trade continues to expand. While stronger European nations such as Germany and France were the initial beneficiaries of improved growth last year, it can be expected that the recovery will broaden with smaller countries such as Italy and Austria showing good signs of improvement.

The European recovery is not without risk and the strength of the Euro is of concern to exporters with the majority of sales outside of the European Union.  Tapering of quantitative easing and increases to official rates are likely to be a cause for concern for investors as the European economic recovery reaches a level of being self-sustaining. This has the potential to add further strength to the Euro and potentially stifle European growth as export growth slows for European nations.

While it is not a front-of-mind risk for investors in Europe, the potential exists for Brexit negotiations to change trade relationships within Europe for both the broader European Union and the United Kingdom. As details and timelines come to light there is potential for winners and losers to emerge.

Emerging markets to continue strong performance

Emerging markets generally performed strongly in calendar 2017 with the MSCI Emerging Markets Net Return (in AUD) returning 26.8%. Asia share markets have been particularly strong with the MSCI Asia ex Japan net return index (in AUD) returning 30.9%. The Brazilian sharemarket gained 26.9% in local currency terms, while the Russian sharemarket rebounded strongly during the second half of 2017 finishing 16% higher than its mid-year low.

In 2018, we believe some emerging markets can continue to provide good sharemarket returns, but a repeat of the stellar returns of 2017 is unlikely. Larger emerging markets such as China, South Korea and Taiwan appear well placed to be strong performers while Russia may surprise in the positive if improved oil and gas prices can be maintained for much of 2018.

Risks for emerging markets include:

• Increased tensions on the Korean Peninsula which will impact directly on South Korea, but also have the potential to drive a wedge between the US, Russia and China.
• A trade war developing between the US and China for the reasons discussed above.
• Whilst the result of the Russian Presidential election appears a fait accompli with Vladimir Putin likely to be re-elected, it will be the lead up to the election in March that will be monitored closely by the world with a close eye on human rights.

Summary

2017 was a good year for most sharemarket investors. And the strong global economic backdrop should continue to provide a tailwind for most sharemarkets in 2018.

As always, there are risks, and volatility will no doubt return at some stage. Therefore, investors should remain vigilant, with capital preservation firmly top of mind.

Valuations are becoming stretched in some instances, with US stocks in particular now appearing expensive.

In conclusion, while the momentum from 2017 looks like it will carry into 2018, investors should not be complacent. Investing is a long term exercise, and that means enduring all market conditions through appropriate objective setting, asset allocation and capital preservation.

Disclaimer: This article is not legal or personal financial advice and should not be relied on as such. Any advice in this document is general advice only and does not take into account the objectives, financial situation or needs of any particular person. You should obtain financial advice relevant to your circumstances before making investment decisions. Where a particular financial product is mentioned you should consider the Product Disclosure Statement before making any decisions in relation to the product. Whilst every reasonable care has been taken in distributing this article, Australian Unity Personal Financial Services Ltd does not guarantee the accuracy or completeness of the information contained within it. Any views expressed are those of the author(s) and do not represent the views of Australian Unity Personal Financial Services Ltd. Australian Unity Personal Financial Services Ltd does not guarantee any particular outcome or future performance. Australian Unity Personal Financial Services Ltd is a registered tax (financial) adviser. If you intend to rely on any tax advice in this document you should seek advice from a tax professional. Australian Unity Personal Financial Services Ltd ABN 26 098 725 145, AFSL & Australian Credit Licence No. 234459, 114 Albert Road, South Melbourne, VIC 3205. This document produced in January 2018.

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