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Will the good times continue in FY18?

Anthony Fensom  |  11 Jul 2017Text size  Decrease  Increase  |  

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Fiscal 2017 saw healthy gains for both Australian share and residential property investors, despite plenty of reasons for caution. Will the new financial year prove as profitable?

 

As at 30 June 2017, the benchmark S&P/ASX 200 index was showing a 9.3 per cent gain from the prior year at 5,721. Including dividends, the S&P/ASX 200 Accumulation Index was up 14.1 per cent at 55,759, its best gain in three years, outperforming the 13.2 per cent rise in dwelling prices.

However, returns on government bonds fell by 0.8 per cent, posting their weakest return in 23 years, with official interest rates in Australia staying steady at a record low 1.5 per cent but slowly rising in the United States and other economies.

Australia's 10-year bond yield finished the financial year at 2.6 per cent, up from last June's 1.99 per cent but down from its high of 2.99 per cent.

Among the ASX's 21 industry sub-sectors, the biggest winners were consumer durables (up 40 per cent), followed by food, beverages, and tobacco (up 29 per cent), and capital goods (26 per cent higher).

At the other end, the biggest losers were telecommunications (down 26 per cent), property trusts (minus 10 per cent), and real estate (down 8.5 per cent).

Small-cap stocks underperformed in fiscal 2017, with the Small Ordinaries rising by just 3.7 per cent compared to the more than 9 per cent gains of the ASX 50, ASX 100, and ASX 200, and the 14 per cent rise of the MidCap 50.

Among ASX 200 stocks, coal miner Whitehaven Coal (ASX: WHC) was the biggest riser, up 167 per cent, followed by dairy company A2 Milk (ASX: A2M) (up 115 per cent), and steel producer Bluescope Steel (ASX: BSL) (up 107 per cent).

The worst performers were telecommunications company Vocus Group (ASX: VOC) (down 60 per cent), graphite miner Syrah Resources (ASX: SYR) (minus 53 per cent), and telco TPG Telecom (ASX: TPM) (51 per cent lower).

Morningstar's head of equities research, Peter Warnes, has predicted the S&P/ASX 200 Index could finish 2017 at around 6,000 in a "bull" case, with a base case at 5,600, and a bear case of 4,800. However, he expects annual returns to be lower in the year ahead due to central banks removing the "punchbowl" from the global equities party.

"While global equities markets could move higher in the short term, the concerted move by central banks to rein in accommodative settings and tighten monetary policy will impact the course of equities markets over the coming year," he says, noting moves by not only the US Federal Reserve but also central banks in Canada and Europe to tighten policy.

As well as an "arm wrestle" between the Fed and Wall Street and bond markets, with the latter remaining unconvinced about the prospects for higher inflation, Warnes points to geopolitical tensions, as well as concerns over China's debt level.

Record-beating economy

Domestically, Australia's economy has entered its record-beating 26th straight year of growth, helped by a residential property boom in Sydney and Melbourne and improved commodity prices.

The record may be further extended in fiscal 2018, with the Reserve Bank of Australia (RBA) and other forecasters expecting continued growth of around 2 to 3 per cent in the year ahead.

However, Warnes suggests a reduced contribution from the housing sector along with lower demand from China could result in a weaker economic outlook, amid sluggish wages growth and depressed household savings.

"The record household debt-to-income ratio will make it difficult for the RBA to aggressively lift official interest rates. Out-of-cycle increases driven by macroprudential measures have already increased sensitive investor and interest-only rates," he says.

"A sharp fall in housing prices would almost certainly push an already struggling economy into contraction, and possibly recession."

For Australian investors, tighter US monetary policy could weaken the Aussie currency and benefit companies with US dollar earnings, including pallets supplier Brambles (ASX: BXB), biotech CSL (ASX: CSL) and US-UK shopping centre owner Westfield Corporation (ASX: WFD).

Based on Morningstar's research methodology, Warnes notes current favourites include Brambles, New Zealand power company Contact Energy (ASX: CEN), hospital group Ramsay Health Care (ASX: RHC), Westfield, and "big four" bank Westpac Banking Corporation (ASX: WBC).

Looking overseas, Warnes argues US stock valuations are stretched, helped by surging inflows from passive vehicles such as exchange-traded funds along with low interest rates.

With increasing questions over the timing of tax cuts and infrastructure spending, weaker-than-expected US growth could result in a share market correction of 10 per cent plus from current levels.

Meanwhile, the European Central Bank is seen delaying any interest rate hike until late 2018 or early 2019 amid muted inflation.

In China, the government is expected to achieve its 6.5 per cent GDP growth target but momentum could slow, with falling fixed asset investment leading to lower demand and prices for Australia's coal and iron ore exports.

Concerns for Australian investors include house prices, wages, and jobs growth, along with geopolitical issues including Brexit, US protectionism, and North Korea. Yet such risks failed to noticeably dent financial markets in fiscal 2017.

With official interest rates set to remain steady for another year, the "Lucky Country" could extend its economic winning streak even further in fiscal 2018, keeping the good times going longer for local investors.

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Anthony Fensom is a Morningstar contributor. The author owns shares in CSL and Ramsay Health Care. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria. The author does not have an interest in the securities disclosed in this report.

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