2017 market outlook

Last year, 2016, will be remembered for its political upsets – Brexit, the rise of populism in Europe, and the election of Donald Trump – but also the year that we stopped talking about deflation, yields on government bonds rose and investor spirits were reignited. Because of this, there is a new equation for investors; one where better growth plus a bit more inflation adds up to a change in approach to fixed income and the share market.

Global outlook: Changing seasons

Growth in the world’s major developed markets – US, Japan, and Europe – is brighter as a result of rising business and consumer sentiment and a pick-up in manufacturing activity. There is also the anticipated boost to growth from increased government spending and recognition by central banks that higher yields, not lower, is good for economic growth. While not quite as sunny as developed economies, the storm clouds over the emerging world are no longer as heavy. Brazil and Russia are emerging from deep recessions on the back of rising commodity prices and a generally more favourable political outlook.

Most importantly for Australia is the more stable outlook for the Chinese economy. The rate of economic growth in China may slow this year but fears of a collapse are no longer imminent.

US shares should continue to perform well given the potential boost to after tax profits from changes to the corporate tax structure. Elsewhere, weaker currencies should support Japanese shares and possibly the Eurozone.

Australia: Fairer winds

The outlook is one of reducing headwinds and a stronger pace of economic growth over 2017. The drag from the decline in mining investment is diminishing, higher commodity prices should feed into rising levels of national income and increased trade, a continued strong pipeline of home building, and finally the potential for fiscal policy to be eased.

More vigour in the Australian economy, and concerns around the very high levels of household indebtedness, may stave off further cuts to the official cash rate by the Reserve Bank of Australia but there remains a downward bias. As such the Australian dollar faces further weakness as the US dollar rises, but currencies are never that simple, and demand for commodities may lend support to the ‘Aussie’. The domestic share market should perform ok once again this year as commodity prices are higher and rising bond yields help the financial sector. However, much of the promised performance is concentrated within a narrow range and corporate earnings will have to live up to analyst’s optimistic earnings forecasts.

Risks: Politics and populism (international)

The political calendar will be heavy in the coming year and represents some of the biggest risks to investors. Close to half of the population of Europe will vote in national elections this year. The negotiations will start on details about how the UK will extract itself from the European Union and then there is the unknown quantity that is the new Republican government in the US. Political promises from the US should be viewed with some trepidation given the constraints of fiscal spending and an already limited number of workers.

The new investment equation

The shifting fortunes for bond and share markets through 2016 rewarded those investors with a risk-orientated portfolio and once again highlighted the benefits of diversification. Investors should be thinking of single digit gains on a well-diversified portfolio but changing the way they achieve it. A better economic footing and shift to fiscal over monetary policy should see shares do better relative to bonds and point investors towards more cyclical sectors over ‘bond like’ shares.

Investors should look to avoid longer maturity government bonds and think more about corporate credit for income. However, while the forces that created the demand for safe assets have diminished, they have not gone away and the search for both income and new forms of ‘safety’ within portfolios will continue to be crucial.

Speak to Wynyard Park Private Wealth about investment opportunities in the year ahead.

Source: JP Morgan