End of Quarter Review

The combination of synchronised global economic growth combined with tame inflation provided the backdrop for equities markets to move higher in 2017. Tax cuts resulting from the passing of Trump’s Tax Plan in December 2017 contributed to the S&P 500 index hitting an all-time high, closing 2017 up 19.4% at 2,674 points.  The MSCI World Index gained 20.1% to 2,103 points.

Market review

Domestically, the Australian S&P/ASX 200 index gained 7.0% to 6,065 points, where the very low levels of market volatility were highlighted by the index remaining within a narrow band of 9.1% between the high and low for the year. The Health Care sector was the strongest performer in 2017, gaining 24.0% aided by CSL’s yearly gain of 40.7%. 

The Energy sector gained 20.6%, boosted by OPEC and Russia agreeing to extend oil production cuts of 1.8 million barrels per day from March 2018 until the end of 2018.  The Brent oil price increased from US$57 per barrel at the end of 2016 to US$67 at the end of 2017.  After being the strongest performing sector in 2016 with a gain of 39.1%, the Materials sector increased a further 18.5% in 2017, with the iron ore price consolidating on 2016 price gains.   After starting the year at US$79 per tonne, the iron ore price recovered from a year low of US$53 in June to finish the year at US$76 per tonne (US$71 year average).

The Financials sector posted a 0.4% decline for 2017, with the Turnbull Government announcing on 30 November it will establish a royal commission into alleged misconduct in the banking, superannuation and financial services industry.  The worst performing sector was Telecoms, which fell 26.6% on the back of a 28.8% decline in the Telstra share price on concerns of a potential earnings gap once Telstra customers transition to the NBN. 

Government bond yields remain near historical lows despite the US Federal Reserve posting three 0.25% hikes to the Federal Funds Rate over 2017 taking its current target range to 1.25-1.50%.  US 10 year bond yields fell 0.04% over 2017 to 2.41% while Australian 10 year bond yields fell 0.13% to 2.63%.  The recovery in commodity prices has contributed to the Australian dollar increasing from US72 cents to US78 cents over 2017.

Investment environment

The increase in Australia’s annual economic growth rate to 2.8% for the September 2017 quarter was a result of stronger investment spending offsetting a weaker than expected 0.1% increase in household consumption expenditure.  Underlying inflation has remained below the Reserve Bank of Australia target band of 2-3% since December 2015, with September 2017 inflation at 1.9%. 

Looking forward, we forecast the Australian economy to grow by 2.9% in calendar 2018 and then 2.8% in 2019. In comparison, we expect the world economy to grow by 3.4% and 3.3% in calendar 2018 and 2019 respectively.

A continuation of the trend of low inflation plus a cooling in the residential property market provides scope for the Reserve Bank to retain the official cash rate at 1.5% over 2018.

Share market outlook

The Australian share market is currently valued on a forward consensus price earnings ratio of 15.9x, which is 8% above the long term average of 14.7x. The forward consensus dividend yield for the Australian share market is an attractive 4.5% (80% franked) and this also continues to attract investors searching for yield, particularly given the very low interest rates that currently prevail.

All up, modestly positive domestic and global indicators should enable the Australian share market, as measured by the S&P/ASX 200, to reach our year-end target of 6,400 in December 2018, which is 5.5% above the 31^st December 2017 close of 6,065 (excluding dividends).