Market Outlook – December 2017


Equity markets have performed strongly over the past year on the back of an improving outlook for the major economies. Global growth continues to show positive signs, confirming the debt deflation cycle is rolling over to a more traditional industrial cycle. Global PMI data continues to support the first synchronised global growth cycle seen in many years, and this is being reflected in strong earnings growth. However, geopolitical risks, including tensions with North Korea, will continue to weigh on the market. These geopolitical factors and central bank policy dynamics will continue to provide challenges to investment market performance and economic optimism.

In China, the 19th Party Congress has charted a course that involves less pollution, less reliance on property construction and further increases in the services sectors that should result in a more balanced economy. The expectation is that over the next five years, fixed asset investment will slow and GDP growth will move from around 6.5% to circa 5% as China’s economy becomes consumption driven.

The Australian market saw quite a large rotation away from defensive and bond proxies towards the cyclicals and value end over the past 12 months. Our view is that this correction, albeit stalled, still has some way to go, given the extent of the bubble, and should be driven by rising global inflation, and therefore earnings growth in the more economically-sensitive sectors. Comments from both the US Federal Reserve and European Central Bank suggest they are on a path of reducing their balance sheets. This is likely to put further upward pressure on bond yields, despite some central banks maintaining quantitative easing programs.

The current market PE ratio appears around fair value, based on the average of the past 20 years of low inflation. It appears we have entered into an earnings expansion phase that could last many years. The typical earnings expansion results in rising markets and falling PE ratios. Under-earning and undervalued stocks typically do well in the early stages of such a recovery.

Our expectation is that the rotation that commenced in August 2016 will continue, and this combined with earnings growth will drive market returns. The risks to this view are geopolitical volatility and more muted earnings growth, which could both provide obvious headwinds.