Australia is one of the few countries in the world that close out their financial year in June. So to Australian investors, we wish you a happy financial new year and ask what will be of the twelve months to come?
The 2017 financial year was kind to equity investors. The MSCI Total Return Index (global market) delivered investors more than 18 percent. And the nature of these returns is even more interesting: over the last eight months since the election of President Trump last November, global equity returns have delivered unusually consistent monthly returns.
Over this eight-month period, the global market put on 15 percent, but with a maximum and minimum monthly return of 2.8 percent and 0.4 percent, respectively.
Contrast this to the prior 15 months which delivered a negative return of nearly two percent, with maximum and minimum monthly returns of 7.9 percent and negative 6.6 percent, respectively.
The final eight months of the 2017 financial year can be characterised as a perfect Goldilocks scenario. Global monetary conditions remained highly accommodative, Chinese fiscal stimulus remained in full force and the Republican triple-sweep in the US election provided the markets with fresh anticipation of new fiscal stimulus. As if this were not enough, President Macron’s win in the recent French election removed a significant financial tail-risk associated with a potential referendum on France’s membership in the European Monetary Union.
The stars aligned in recent months but where to from here? Well, a logical place to start would be to examine the drivers of the recent Goldilocks period and consider the extent to which they will persist.
First on monetary conditions: the most important recent development was the Federal Reserve’s third interest rate hike for the 2017 financial year. But the increase in the Fed’s policy rate was not the main event. For the first time since it began its quantitative easing program in 2009, the Fed announced it would start a gradual unwind of its US$4.5 trillion dollar balance sheet sometime this year. This means a major buyer of Treasuries and mortgage-backed securities will be exiting the market. This should result in weaker bond prices and, therefore, higher bond yields. And this means higher borrowing costs for corporates and households. All else equal, this is a headwind for equity returns.
Next, the Chinese stimulus has well and truly marked its first anniversary. The nature of growth, of course, is that all of last year’s achievements need to be repeated and then more. This is becoming increasingly difficult for the Chinese economy given the size of its 2016 stimulus and growth has already started to slow.
And what will become of President Trump’s fiscal stimulus? It is far from a done deal. Recent attempts to “repeal and replace” the Obamacare have uncovered sharp divisions within the Republican Party suggesting agreement over future tax reform is also far from assured.
Yet, global markets have already banked a lot of Trump’s intended gains. Should they not materialise to the fullest extent, then equity markets are looking expensive. Consider the price-to-earnings (PE) ratio of the global market – a crude measure of the market-wide valuation level. Today it is around 21 times. In 2015, it was around 19 times. In 2013, 17 times; and in 2010, 15 times. Remember, the higher the valuation level, the lower the expected future return.
No one knows what the future year will hold. But a repeat of the last eight months is unlikely. What is more likely is a return to volatility. And while volatility can be uncomfortable, for the prepared investor, it can be a period of terrific opportunity.
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Andrew is responsible for managing the Montgomery Global Fund, ASX-listed Montgomery Global Equities Fund (ASX:MOGL) and global equity long/short strategy, Montaka Global Fund. Andrew oversees $500m in FUM.