On the sporting field, in the political arena and in equity markets, 2016 has been the year of surprises.

The Western Bulldogs, the Cronulla Sharks and the Chicago Cubs surprised the sporting world with their unexpected and historic triumphs.

Off the sporting field, there were more upset wins by underdog contenders including Donald Trump’s victory in the race to the White House.

After initially being shocked by the outcome of the US presidential election, as well as the Brexit vote, sharemarkets globally defied predictions of steep falls and rallied.

As the year draws to a close, it is pertinent to reflect on some of the other key themes and features of the Australian equity market in 2016, and consider the factors that will drive the sharemarket’s performance in the year ahead.

Expectations proved wrong

At the start of the year, the consensus outlook for the Australian economy and the equity market were quite bearish with expectations of continued poor economic conditions and lacklustre share market performance.

With the S&P/ASX All Ordinaries Accumulation Index falling 5.4 per cent in January to record its worst start to the calendar year since 2010 and March quarter core inflation data revealing the weakest CPI reading since 1983, it appeared the downbeat forecasts were on the mark.

Despite these early negative indications, the Australian economy has performed reasonably well, particularly in recent months. There are now tentative signs the economy is strengthening with recent data showing unemployment rates are stabilising.

We believe inflation is on the rise and GDP growth will start to trend upwards into 2017. The RBA is now taking a more hawkish stance on interest rates with the next move in official rates now likely to be up in our view.

The sharemarket has recorded solid gains, up about 7 per cent (at the time of publication) from the intraday lows on November 9 when Mr Trump was elected, with potential for a “Santa Rally” to push equities higher before the year’s end.

Traders’ market

The overall positive performance of Australian and international equity markets this year belies high levels of volatility, including in the aftermath of the US presidential election and Brexit.

With financial markets pricing in a “remain” vote, the outcome of the British poll led to a violent sell-off in global equities. Similarly, with markets as well as bookies and pollsters anticipating Hillary Clinton would be the next US president, Mr Trump’s surprise win caught investors off guard and equity markets again plummeted.

Despite the markets’ initially negative response to these events, sustained and dramatic declines did not transpire as expected. Instead, equity markets went on to stage strong recoveries. Notably, in the US the “Trump bump” propelled all four major indices to hit record highs in November.

The surge in financial market volatility created by the Brexit vote and Trump’s victory created excellent trading opportunities with active investors well positioned to capitalise on these market conditions.

Banks back in favour

At the start of the year, Australia’s big four banks were broadly shunned by the market as investors feared the potential impact of new Basel IV capital requirements on bank balance sheets.

Last month, however, investors’ concerns were assuaged following comments by Australian Prudential Regulation Authority chairman Wayne Byres indicating it was likely less capital would be needed to meet the capital adequacy requirements and implementation of the new standards was not imminent.

Prospects of a further round of bank capital raisings early in 2017 have been delayed, possibly indefinitely, with the banks potentially able to generate capital organically and through their dividend reinvestment plans.

Small-cap rally wanes

Small-cap companies continued their spectacular rally outperforming their large-cap counterparts in 2016. Over about the past 12 months, the S&P/ASX Small Ordinaries Index has risen 10 per cent. By contrast, the 200 largest ASX-listed companies are up just 4 per cent.

However, the strength of small-cap stocks is now waning as valuations reach unsustainably high levels and there is not the earnings per share to justify the high price to earnings multiples these small companies are trading on.

Notably, over the past two to three months small-cap companies have started to significantly underperform relative to large companies.

IPOs average performers

Mergers and acquisition activity and the initial public offering market have continued to be robust, particularly in the second half of 2016 with up to 30 companies slated to make their market debut before the end of the year.

Despite the strength of the IPO market, in our view the overall quality of companies listing has diminished compared with 12-24 months ago. Generally, the performance of newly listed companies has been average with many failing to trade above their issue price, while others are trading considerably lower.

In recent months, the IPO market has floundered as various deals have been cancelled, postponed or re-priced.

Global events

Looking to the year ahead, we expect the Australian economy will continue to show signs of growth, albeit modest. The government’s fiscal position is likely to improve with the increase in spot iron ore prices boosting the taxable income of many mining and mining-related companies.

We anticipate the Australian sharemarket will be heavily influenced by global events including how and when the UK exits the European Union and investors digest what these developments mean for the future of the world’s second largest economy.

In the short to medium term, we expect the high degree of uncertainty surrounding the implementation of President-elect Trump’s election policies will contribute to continued volatility in equity markets.

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