Mint Outlook for 2018
22nd January 2018
Paul Richardson, Chief Investment Officer
Greg Fraser, Senior Equity Analyst
The powerful tailwinds of 2017 have persisted into the New Year, helped by a one sided US market (seeing only good news) and a Global economy sensing coincident growth for the first time in a decade.
The saying “bull markets must climb a wall of worry” has possibly never seemed so true. North Korean missiles, awkward Presidential tweets and a plethora of international political and trade quarrels have failed to dissuade investors. Markets have instead marched on by more than 20% for the year.
Asset strategists have been pointing to a risk of interest rates backing up, feeding doomsayer speculation of a possible bond rout. The surge in US short rates late December seemed to be the long awaited proof of this. Instead, share markets picked up as earnings momentum improved and as the outlook for the new tech stocks firmed. Even an oil rebound to near US$70 (on OPEC and Russian production discipline) has not dampened risk markets much.
In the cold light of day - or should we say warm? - there would seem to be many pointers for increased risks in the share markets in 2018 and 2019. Stocks valuations are high, earnings growth is not strong, interest rates must normalise (at some point), ETF growth brings liquidity risks, and a torpedo from left field such as geopolitical tension or a sharp decrease in Bitcoin value might trigger a collapse of confidence.
Fortunately, the global economies do seem to be picking up thanks partly to a decade of massive financial support (i.e. quantitative easing). The surge in commodity prices and demand for IPOs signal a cycle that has some way to run. We are expecting many US, European and Asian companies to report better growth in earnings. Furthermore, corporate balance sheets are in such good shape that we may see a surge in mergers and acquisitions.
The dramatic cut to US corporate tax rates has thrown fuel on the fire which, according to the IMF, will also promote economic world growth.
In sunny New Zealand however, we may be near the end of the golden weather (to take a title from both playwright Bruce Mason and expat economist David Skilling) with many aspects of the local outlook that give us cause for concerns. The 2017 General election and the temperament of the new coalition government do raise the spectre of a major change in direction. Under the “Key years”, NZ economic growth was driven by a strong migration, accordingly a potential slowdown is bound to have a negative impact.
The soaring valuation of housing and of the share market, the rising construction costs, a surging infrastructure bill and the risk of a lower NZD (that will push up imported goods costs) could be an offset to what should be a strong export outlook. The Labour led coalition Government is sprinting through its first 100 days of policy objectives - most of these targeting low wages and green policies – but business confidence has taken a hit.
Our internal valuations of the companies that make up the NZX50 index lead us to conclude that a repeat of 2017 is difficult to see. That being said, this sort of fundamental approach can be a poor predictor if global market euphoria takes hold (and many charts suggest that this is indeed underway). At the start of 2017 we expected circa 5% NZ share market growth and we got 22% - albeit that outperformance was due mainly to the high growth export names that we’ve liked (A2, Fisher and Paykel Healthcare and Xero).
Our inclination in early 2018 will be to seek to own what we believe to be high quality stocks, and continue to search for underappreciated stocks and sectors where a management or governance change puts growth back on the agenda.
We have already spent some time in the latter months of 2017 re-calibrating our portfolios to try to reduce our exposure to sectors that may be adversely impacted by new government initiatives. As a result, we are already overweight to export led stocks, as they may benefit from a lower NZD. We are also increasingly looking across the ditch and further afield for growth. It is important to say that we believe socially responsible investment strategies will continue to be a key part of this.
Like the changeable weather, there is an unsettled feel to the Australian market as the New Year begins. The turgid state of politics at both State and Federal levels has created a policy vacuum and greater uncertainty for investors, especially at the corporate end of the market. That may continue as various State elections and potential Federal by-elections will distract the Government from any substantial decisions to boost economic growth.
The Royal Commission of Inquiry into the Financial sector (Banks in particular) can only result in some hefty fines, serious admonishment of management practices and subsequent public apologies from Boards. It may or may not lead to better corporate behaviour within the sector but it is unlikely to change the underlying profitability. The banks remain in slim-down mode as they exit life and general insurance businesses and retreat from Wealth Management. The potential IPO of CBA’s Colonial First State Global Asset Management group could be one of the largest floats of the year.
Commodity prices are always the biggest swing factor in resource company profits, so with oil and iron ore at reasonably good levels, expect to see some genuinely good results from this sector in 2018. The big diversified miners BHP and RIO have been on a capex and cost diet such that the cash flow will be positively rippling and investors should see fatter dividends as the Boards eschew the temptation of making new acquisitions.
The Amazon monster crept into town late in 2017 but failed to scare off the local retailers. As the crucial Christmas period for sales begins to reveal the numbers, it will not surprise us to learn that most retailers have avoided dismemberment by the online threat. However, the early signs of a good Christmas for retailers may not translate to a solid year as wage figures still show households are not seeing much income growth.emergence of the financial technology sector in Australia last year was a standout feature. Expat Xero will join the throng shortly and be competing alongside some very interesting challengers to the traditional platforms for money and transaction flows. The convergence of smartphones and devices with new emerging online payment systems is providing a high risk - high reward scenario for this sector. Bitcoin (and other cryptocurrency) mania will provide plenty of on-going headlines but will remain outside the mainstream for now.
In summary we expect markets to be driven more by momentum and with focus on growth stories, capital goods and commodities and less on the interest rate sensitive sectors, and for overall returns to be lower than 2017 but still healthy.