Glenn Freeman: I'm Glenn Freeman for Morningstar and I'm joined today by our head of equities research Australasia, Peter Warnes.

Peter, thanks for your time today.

Peter Warnes: Pleasure, Glenn. Always good to be here.

Freeman: Now, Peter, in your forecast for 2018, what is your outlook for markets and what's driving this?

Warnes: Yeah, Glenn, a good question. I'm not trying to be contrarian for contrarian sake. But I do feel that these markets are stretched and I'm saying that there's a possibility, and a good possibility, that the markets could finish lower in 2018 than their exits in 2017. People have lost the focus on exogenous factors or a black swan event and there is plenty of fertile ground out there for one of those to sprout in 2018 in my opinion.

We are going to see a clash, and a major clash, of monetary policy and fiscal policy on a scale that we haven't seen before. The Fed is tightening, and it has to reduce its balance sheet and normalize it from US$4.3 trillion and it's got to get interest rates higher should some event occur. So, they have got some ammunition. Offsetting that you have a record peacetime fiscal stimulus. Tax cuts of $1.4 trillion unfunded at this stage. $1 trillion of infrastructure spend over the next 10 years. Combined, that is a major, major stimulus to fiscal policy, which has not been at work since the GFC.

The politicians and fiscal policy have let the economies in the countries down because they didn't come to the party earlier. China did in 2009 and 2010 stimulated and sensibly spent billions of dollars, trillions of dollars on long-term infrastructure, 16-lane highways, crisscrossing vertically and horizontally a fast train network that will last for a long time. We went down the road of doing something. We gave everyone $900; we went on our education or school whole building spree and we stuffed Pink Batts in everyone's roof. Now, that was poor fiscal spending.

Going forward, when you have that clash, it's going to make it more difficult for the Fed and the new Fed chairman how they handle fiscal policy. So, I'm conscious of that. I'm also conscious of the fact that we have record margin debt in the U.S., we have record corporate debt in the U.S, and that market has been supported by record share buybacks, the majority of which have been debt-funded. And on top of all that we have this boom in open-ended equity ETFs. I think you put all those together and we could see a meaningful correction and that might not be very, very pleasant.

Freeman: And Peter, volatility is something that's been broadly discussed. Do you expect this will return into 2018 and beyond?

Warnes: Well, Glenn, that's one of the things that the low volatility or the offset of that, the high complacency, has been an unusual of an event. I mean, yes, we've had for risk assets a perfect environment, low inflation albeit and some low growth. But now, don't forget, you have a synchronization in global growth, particularly, in the Northern Hemisphere. And so, that's positive. And look, the near-term momentum for markets will probably and I suspect will, in the first quarter, push markets higher. All I'm saying is, I'm asking you to be aware, asking subscribers to be aware that there are some dangers out there.

And so, as the Fed starts continuing to tighten, if we do get a flash of inflation, in other words, somehow, the Genie gets out of the bottle and we get some wages growth and that's what's going to drive this inflation, and that forces the Fed to tighten faster than the markets are anticipating. If that happens, then what happens is that risk asset prices will correct. So, people have got to understand that we are in an environment where prices are high. You've got to make sure that the margin of safety you – in other words, you are getting paid for the risks you are taking.

So, I do expect volatility will return, because these markets are full of expectation. The US market is up just about 20 per cent on the expectation that Trump would deliver. Well, he is about to deliver one of four of his platform promises and that will be tax cuts. But the market is already up 20 per cent on the expectation that it will be delivered. When it's announced, it could easily be a, so the fact, because you've already bought the rumour. So, I do expect volatility will return. I do expect people to be--a shock to their complacency.