Uncertainty delivers positive returns
Global markets surged this year. How did your portfolio fare?
Summary: Investors entered 2017 with trepidation, but global share markets behaved in ways many didn't expect. Analysts have highlighted 2017 as a "watershed year", where global synchronised growth finally went into full gear. Eureka Report checks out how the Australian share market fared against the best performer of the year.
Key take-out: Every single sector, apart from telecoms, has gained year-on-year – but the ASX still underperformed its global peers by around 10 per cent to mid-November. Australian shares have seen corrections of between 5-7 per cent this calendar year, despite a backdrop of mostly positive economic data, but investors should note a recent change in sentiment.
We're about to call it a wrap on one of the most peaceful years in modern history.
Didn't feel that way? With random interceptions by Donald Trump and Kim Jong-un, maybe not; but by most measures, it's been a stretch of calm.
In Australia, the ASX 200 has only experienced 26 days where it has fallen or risen by more than 1 per cent. That's the lowest result in more than 12 years, since the year ending September 2005. And, in the US, the CBOE Volatility Index, which tracks short-term S&P 500 fluctuations, is near record lows. The volatility gauge fell to a record low on Black Friday in late November.
The ASX 200 has put on around 6 per cent in the year to mid-December, and including dividends, more than 9.5 per cent. This pales in comparison to the S&P 500, which has gained more than 20 per cent, but that still lags MSCI emerging markets, which have added more than 30 per cent on average. Hong Kong's Hang Seng looks likely to take the spot as 2017's best performing market on a global scale, gaining just over 30 per cent, and the German DAX has been the best performer in Europe, up almost 14 per cent.
Political risks were everywhere in 2017, but they turned out to be less threatening than initially feared. North Korea ramped up missile tests, but these had a mild impact on markets; Trump's presidency turned out to be a positive for business; a trade war with China never escalated, nor did a China debt crisis; and Eurozone elections saw pro-Euro centrists win out.
The global economy finally started to kick into full gear this year, nearly a decade since the start of the global financial crisis. Analysts at Macquarie described 2017 as a “watershed year” for being the first since the GFC that markets have gained real traction across the board. Emerging markets joined the global party in 2017, showing a growing resilience to shocks suggestive of these markets, like China and India, maturing as asset classes.
This turnaround is no better illustrated by the fact that following continual downgrades from 2011 to 2016, forecasters have for the first time since 2010 upgraded their outlooks in recent months:
Markets are emboldened, and over this last month we've seen a raft of global stock markets either hit record highs or lift to multi-year highs. In light of that, Eureka Report recaps how different areas of the market have fared this year.
Dominated by banks and miners, the Australian market was never going to be a major beneficiary of the US technology boom, and that's part of the reason the ASX has underperformed its peers. Our IT sector makes up just over 1 per cent of the local market.
Every single sector, apart from telecoms, has gained this year – but the ASX still underperformed its global peers by around 10 per cent to mid-November. Australian shares have seen corrections of between 5-7 per cent this year despite a backdrop of mostly positive economic data.
However, the recent earnings season that ended in August was positive, with 91 per cent of full-year reporting companies making a profit and 91 per cent of companies issuing a dividend. Australia might be in the background of this global rally but, that last point considered, it's the runner-up to New Zealand in 12-month forward dividend yields.
It wasn't until October when things really kicked into gear here and the local market started playing catch-up to the global equities rally to make some of its strongest monthly gains in the last two years.
Without an Australian-specific catalyst, the ASX 200 pushed through 6000 points in November for the first time since 2008. Speaking broadly, a better-than-expected US reporting season, greater confidence surrounding Trump's tax cuts, and relatively dovish central bank policies helped move markets higher.
By and large, small caps listed on the ASX have fared better than our larger companies, dramatically picking up pace from August. That also seems testament to the factors above, according to CommSec chief economist Craig James, where the state of play is encouraging investors to take on more risk.
“As always though, a question of balance is important. While irrational pessimism is not a sustainable situation, neither is irrational optimism,” says James, speaking of the trend towards small caps.
“There are exciting opportunities in the share market across a range of sectors including mining, food, beverages and tobacco, pharmaceuticals and biotech, and information technology. But while some of the companies in these sectors have potential to grow, they may be regarded as operating in a higher risk/higher return quadrant.”
The chase for yield is clearly accelerating, and with the banks rocking the ASX several times this year, investors are looking outside our traditional sectors. The banks form the backbone of the local share market, and with a crackdown on housing lending, higher taxes, a rising risk of bad debts from a property slowdown, and a looming Royal Commission, their best days could be behind them for now.
The materials sector looks set to finish this calendar year on top of its peers, even if the below chart paints a different picture. Mining's rally has several catalysts, China being key.
China is on a growth trajectory and its large pipeline of infrastructure and construction projects will require significant reserves of base metals, in particular. The Chinese Government has pledged to clean up the nation with environmental reforms that are redirecting attention to higher-quality commodities.
In fact, China is a two-prong catalyst, where the movement towards electric cars is driving up demand for battery metals. Lithium stocks were the first to rally, but cobalt and nickel producers joined in soon after.
Oil prices have ebbed and flowed, but not enough to rouse the analysts, according to the chart above. Essentially, OPEC has done wonders for both Brent crude and WTI prices, which to the end of November were up around 35 per cent from their mid-year lows. This coincided with momentum building around OPEC's agreement to extend production cuts through 2018, confirmed in November.
Naturally, a surprise fall in the US dollar also boosted commodity prices this year, and it's important to note the US dollar has made headway since then. Linked to this and geopolitical events, demand for safe haven assets flowed in intervals throughout the year, but has fallen off markedly since late November.
US tech stocks have been the centre of global attention, but that's missing the critical point that it has been one of the broadest bull markets on record, and on a global scale. In the US, every sector has participated in the rally except for energy and telecom services, which only represent less than 10 per cent of the S&P 500 anyway.
Stocks are primarily being driven by strong economic data, the anticipation of tax reform, and global synchronised growth. The Dow notched up another record for the year — breaking through 24,000 points — soon after the release of Trump's tax blueprint. Bank stocks had their best day since 2007, and laggard telecom stocks climbed the ranks. The tech sector stands to gain the least from the tax cuts, and this was reflected in the rally that followed where, for the first time in a long time, the tech sector wasn't the star of the show.
We also haven't witnessed any meaningful drawdowns in US stock markets this year, keeping the skip in equities' step and adding even more sparkle to the rally.
The largest drawdown for the S&P 500 this year has only amounted to 3 per cent, which is the smallest drawdown in 38 years, helping the S&P 500 hit record highs on a regular basis. The below chart from Morgan Stanley sheds some light on this:
Investors are most wary of high valuations in the technology sector, which rose by around 35 per cent to November – more than double the S&P 500's gain for 2017. The FAANGs – Facebook, Amazon, Apple, Netflix and Google (Alphabet) – led the pack on this.
This calls for comparisons to the dot-com bubble. Back then, the IT sector accounted for more than 30 per cent of the S&P 500's market capitalisation, whereas representation is now around 24-27 per cent. But, the tech sector comprises more than 20 per cent of the S&P 500 earnings these days, which is basically consistent with its market cap representation.
Expect the unexpected
If 2017 has taught us anything, it's to expect the unexpected. Trump, a wild card in every sense, shook markets in ways that almost no one could have predicted. If anything, his election marked the storm before the calm. And where there have been shocks to the system, mainly geopolitical, markets have shown an ability to absorb these and quickly bounce back.
We are late in this expansionary cycle – by most analyst definitions ‘very, very late' – but the positives are still outweighing the negatives, at least for the time being. Eureka Report will share what the experts are saying about the year ahead in the next week, including the investing hot spots.
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