2018 Market Outlook

29 January 2018 

In this report, we outline the key themes which we believe will impact markets in 2018. All else being equal, we expect the Australian market to lag its global peers but still deliver reasonable returns in 2018 of circa 10%. Momentum in global economic activity should have a positive impact on business investment domestically, which should drive earnings growth. Globally, we are moving from a period of low inflation and very accommodative monetary policy (“goldilocks”) to a period in which inflation trends up and central banks’ liquidity is reduced. We continue to expect equities to do well in this environment and bonds to lag. Within equities, we prefer emerging markets, Japan and Europe. We are Neutral on bonds, with a preference for Australia and US. We are underweight credit but accept that given the low interest rate environment and generally solid corporate balance sheets, credit may continue to see demand at current levels, all else being equal.

  • Increased investment should drive earnings for Australian corporates. The momentum in global economic growth looks set to continue in 2018, with solid domestic growth being experienced in most regions. On the back of this momentum we expect (and subject to no major economic shocks – such as a potential China hard landing) this global growth to have a positive impact on Australian companies’ capital expenditure plans. Our analysis of ASX200 companies point to a notable lift in investments when compared to recent years. 
  • Reserve Bank of Australia (RBA) to raise rates in 2018. The RBA cash rate has been stationary at the 1.50% level for the best part of two years now. In our view, the RBA could be pressed to raise cash rates from historical lows as the momentum in global growth and low unemployment lifts wage growth in Australia and inflation moves towards the bottom end of RBA’s target range of 2-3%. 
  • Liquidity drain – central banks reducing asset purchases. The US Federal Reserve will begin to sell assets on its balance sheet, European Central Bank (ECB) will reduce its asset purchase programs and Bank of Japan (BoJ) will also likely follow suit over the medium term. Whilst global economic growth is on a more solid footing, the removal of this liquidity and the flow on (or the magnitude) impact remains highly uncertain. Inevitably, higher rates are negative for risky assets (equities) and given where short them bond yields are in certain regions, a spike in rates expectation could cause a sell-off in bonds. In our view, US Fed deleveraging in 2018 is unlikely to have a material impact on the markets. Where things will become a lot more interesting will be when the ECB and BoJ look to undertake the deleveraging process, potentially in 2019/2020.
  • Equities. In our view, economic conditions in 2018 will again be supportive of equities (risk-on) with low but improving inflation and ongoing momentum in global growth. Whilst the threat of higher inflation, reduced liquidity (pullback from central banks) and rising interest rates will eventually be a negative for equities, we do not believe this will be an immediate concern in 2018, all else being equal. 
  • Fixed Interest. Whilst inflation is not expected to spike aggressively, we do note there are other potential risks that investors should be aware of with bonds. With liquidity easing going forward as central banks pull back on their purchasing programs, one of the downside risks to bonds is the imbalance in the supply and demand equation. We note that China has indicated it may reduce purchasing US Treasuries. With more supply coming (governments and companies’ issuing bonds) and less buyers in the market to provide a backstop, yields could potentially move aggressively higher without central banks’ intervention. Investors could look to introduce inflation-linked bonds to provide some protection.

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