The Experts

Why 2017 is looking better despite the noise

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Of course those who foresaw the “financial crisis of 2016” will just roll their call into 2017! But there are good reasons to believe disaster will yet again be averted.

Leading growth indicators such as business conditions PMIs have reaccelerated after a 2015-16 soft patch and actually point to stronger growth.

There is no sign of the sort of excesses that drive recessions and deep slumps in shares: there has been no major global bubble in real estate or business investment; inflation remains low; share markets are not unambiguously overvalued and global monetary conditions are easy.

While the Fed is likely to raise interest rates several times in 2017 this will likely be offset by fiscal stimulus from the Trump administration equal to around 1% of GDP. Rate hikes are likely to be limited to the extent that the rising $US is doing part of the Fed’s job.

Meanwhile monetary conditions will generally remain easy in the Eurozone and Japan with a further easing likely in Australia, albeit a tightening phase is possible in China.

Against this background:

  • Global growth is likely to move just above 3%, ranging from around 2% in advanced countries to around 6% in China.
  • Headline inflation is likely to continue to rise as commodity prices rise with core inflation rising more slowly.
  • The earnings recession looks to have ended – at least in the US & Australia – with solid earnings growth likely.
  • Bond yields have gone up too far too fast in the short term, but the trend is likely to be gradually up.

For Australia, the economy is likely to continue to rebalance away from mining investment and pick up again from its September quarter decline: the ramp up in resource export volumes has further to go; there is still a huge pipeline of housing activity yet to be completed; strengthening approvals point to stronger non-dwelling construction; the drag from mining investment is fading as it falls as a share of GDP and its likely to be close to a bottom next year; recent retail sales data have improved suggesting a consumer bounce back in the December quarter and the rebound in commodity prices tells us that the income recession in Australia is over.

Expect Australian growth to be around 2.5% through 2017.

However, near term risks to Australian growth are on the downside, inflation is likely to remain below target for longer than the RBA is forecasting, the RBA is likely to need to offset increases in bank mortgage rates and the $A remains too high.

So we expect another rate cut in the first half of next year taking the cash rate to 1.25%. A rate hike is a long way off.

Implications for investors

The combination of some acceleration in global growth, rising profits and still easy money at a time when investors are highly sceptical (and ever fearful of the next GFC) should be positive for growth assets in 2017:

  • Global shares are likely to trend higher and we favour Europe (which is very cheap and likely to climb a wall of Eurozone break-up worries) and Japan (which will benefit from the lower Yen) over the US (which may be constrained after its 2016 outperformance and Fed rate hikes).
  • Emerging markets may underperform if the $US continues to rise on Fed hikes but for now are looking attractive if as we expect the rise in the $US takes a break early in 2017.
  • Australian shares are likely to have solid returns as resource sector profits surge following the rebound in bulk commodity prices, overall profits rise 10% and interest rates remain low.
  • Expect the ASX 200 to reach 5800 by end 2017. In terms of sectors favour resources, retailers, and banks.
  • Commodity prices are at risk of a short term pause/pull back but should remain well up from their 2015-16 lows.
  • Still low yields and capital losses from a gradual rise in bond yields are likely to see low returns from bonds.
  • Commercial property and infrastructure are likely to continue benefitting from the ongoing search by investors for yield.
  • National capital city residential property price gains are expected to slow to around 3-4%, as the heat comes out of the Sydney and Melbourne markets and rising supply hits.
  • Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.5%.
  • The downtrend in the $A is likely to continue as the interest rate differential in favour of Australia narrows and it undertakes its usual undershoot of fair value. Expect a fall below $US0.70 but little change versus the Yen and Euro.

What to watch

The main things to keep an eye on in 2017 are:

  • US economic policy under President Trump – in particular whether the focus is on fiscal stimulus and deregulation as opposed to starting a trade war with China;
  • How aggressively the Fed raises rates – faster inflation could speed it up putting more upwards pressure on the $US;
  • A rapid rise in bond yields – this would be bad for shares and growth assets but a gradual rise would be okay;
  • Elections in the Netherlands, France, Germany and maybe Italy which could reignite Eurozone break-up fears if anti-Euro populists win (which I doubt they will);
  • Whether China continues to avoid a hard landing;
  • Whether non-mining investment picks up in Australia – a failure to do so could see aggressive RBA easing – and how a surge in apartment supply impacts property prices; and
  • Ongoing geopolitical flare ups, eg in the South China Sea.

Published: Monday, December 12, 2016

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