Market Outlook – November 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. 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.

The Australian market has seen 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 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. Recent 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.

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 market return in 2017 will be driven by the continuing rotation that commenced in August 2016 and earnings growth. The risks to this view are geopolitical volatility and more muted earnings growth, which could both provide obvious headwinds.