Key local and global factors for Australian shares over next 12 months.

After a strong performance in FY2017, the Australian sharemarket is positioned to continue its growth into next financial year, and as it approaches it is pertinent to consider the key trends and factors that will drive equities in the short term.

Wilson Asset Management’s predictions for FY2018 include:

1. Global macro-economic strength

Driven predominantly by the US and Chinese economies, global economic conditions are the best they have been since the global financial crisis. The US economy’s growth is accelerating. The continued performance of the world’s largest economy will be underpinned by an improvement in second-quarter economic data, particularly business capital expenditure, personal consumption and durable goods orders.

In our view, these indicators will be positive and the US economy, which is in the mid-to-late stages of the current cycle, will continue to expand. Similarly, the European economy is strengthening. With the eurozone recovery at an early stage of the economic cycle, there is significant potential upside for equities.

2. Australian economy improving

Overall, the Australian economy is continuing to show signs of strength. This is despite waning consumer sentiment and stagnating wages growth, which is hurting consumer discretionary stocks. We predict economic conditions will continue to improve and the economy will grow at a modest rate, supported in part by higher commodity prices and the strength of the east coast property market.

3. Shares to rise

Against this backdrop, our overall view of Australia’s sharemarket in the short term is bullish. The All Ordinaries Accumulation Index up 4 per cent since the start of the 2017 calendar year (at close May 25), in our view the equity market will continue to rise next financial year. We expect resources companies’ earnings growth to continue, and select businesses experiencing growth in the current economic climate will outperform.

Over the medium-to-longer term, our outlook is more cautious, given that we are in the mature stages of this bull market. The average bull market lasts five years. The current one, which started after markets plunged to their post-GFC lows in March 2009, is now more than eight years young.

With markets rising on fear and the majority of investors underinvested as shares have risen, the current bull run has been described as the most “unloved equity bull market of all time”.

4. Retail stocks to struggle

With consumer confidence weakened by out-of-cycle interest rate rises (as banks lift rates) and stagnating wages growth, companies exposed to discretionary consumer spending are struggling. Retail stocks in particular are floundering in the current environment, with footwear retailer RCG Corporation and luxury brand Oroton Group two recent high-profile examples. We anticipate consumer sentiment will remain weak for the rest of the calendar year.

5. Rate rises delayed

While the interest rate loosening cycle is over, a combination of out-of-cycle rises by the banks, together with weak wages growth and poor inflation readings, ensures official interest rates will not be raised until next calendar year.

6. Housing market has peaked

Stimulated by record low interest rates over many years, Australia’s residential property market (particularly on the east coast) has experienced rapid growth over the past five to seven years. However, bank-led rate rises, coupled with increasing levels of personal debt, have had a dampening effect on the housing market, as reflected by normalising price growth.

In our view, the market for stand-alone dwellings will continue to be supported by a persistent undersupply and continued population growth. Future rate increases, particularly further out-of-cycle rises, will be the critical factor influencing house prices in FY2018. Distinct from stand-alone homes, the apartment market is at risk of suffering from an oversupply, given the significant number of these dwellings coming on line in the immediate term.

7. Yield trade to hold up

Record low interest rates over many years have driven investors out of term deposits and into shares, particularly companies with high, reliable dividends. With official interest rates not expected to rise any time soon, investors’ hunt for yield shows no signs of abating in the short term.

8. Small-caps to recover

Over the past six to nine months, small-cap companies have significantly underperformed relative to their large-cap peers by 11 per cent. Institutional investors have transitioned their investment portfolios to other asset classes and large superannuation funds have internalised their investment management functions. We believe around $4–5 billion has been stripped from the small-cap end of the market. However, with banks and resources stocks becoming less attractive, we believe investors will again seek growth in smaller, cheaper stocks, which will drive small-caps’ performance in the near term.

9. IPO pipeline slowing

The market has seen some high-profile initial public offerings (IPOs) abandoned recently as the pipeline of new companies coming to market weakens. Notably, the proposed Zip Industries and Officeworks IPOs failed to attract the requisite investor interest at prices acceptable to vendors. Fund managers cited high valuations as their reason not to invest.

10. Geopolitical risks rising

While the global economic outlook is improving, there are several global geopolitical risks that have the potential to generate considerable volatility for equity markets over the 2018 financial year. The most significant of these is the escalation of tensions between the US and North Korea. Further risk arises from the unpredictable nature of the Trump administration. The potential for further diplomatic disputes to weigh on markets worldwide remains a persistent threat.