Shares should be one of the best-performing assets this year, say Stewart Brentnall and Mark Rider.
Given expectations of fairly solid economic growth for this year, in both Australia and major developed nations, we are favouring shares and similar growth-assets.
Two broad expectations we have for 2017 is that major economies should keep growing but that considerable risks exist. The case for growth is more or less clear.
Financial conditions and policies of the world's major economies are well positioned to support continuing growth this year. As developed economies keep growing, unemployment will likely drop and wages and inflation rise, but not dramatically so.
In our view there is little on the economic horizon to short-circuit the current recovery. We expect low double-digit earnings growth in 2017 to drive modest returns on investments as recovery continues across the world’s major economies.
Perhaps the key area to watch is how the central banks increase interest rates, particularly in the US, as it will be a determining factor in the performance of financial markets this year.
Why favour shares?
But going back to asset classes, the outlook for stronger growth and inflation continues to favour shares over bonds. In ANZ’s investments we will look for opportunities to be more exposed to such growth assets in 2017.
However, we’re not making any radical moves. Shares are highly valued at present, and should be treated cautiously. As we mentioned, how rates rise in developed markets such as the US, Australia and Europe, could impact share prices significantly.
And investors are already behaving as though stimulatory policies suggested by the new US government, such as tax cuts, have been enacted. They haven’t of course, and there is risk these policies won’t turn out as investors envision, something that poses a further risk to share prices. Sharemarket valuations across most developed markets are expensive, the US in particular.
So given this, why do we remain favourable to shares? Because it is stronger economic growth and inflation that will support growth assets this year. And shares should remain in favour as long as three conditions are met:
1. the US dollar's rise levels off
2. US financial conditions remain 'easy'
3. US interest rates keep rising.
Quick review of world markets
But it’s not all about the US. In Australia, shares are expensive. While the Australian economy is expected to maintain growth, business sectors are mostly looking soft, except for residential construction, which is likely to peak soon. And with higher interest rates in the US, our funding costs will rise.
That said, business investment will increase, particularly in major east-coast markets. And consumer spending should maintain healthy growth. Exports will strengthen the economy with increased demand for our services and liquefied natural gas.
Wage growth will continue at its lowly level and inflation will persist below the central bank target of 2 per cent to 3 per cent. The Reserve Bank of Australia is likely to keep the official cash rate at 1.5 per cent.
The outlook for European shares has improved as policies continue to support the economy and the euro has a lower exchange rate, which should continue this year. Risks include a fragmented political scene as elections near and a fragile banking sector, but British shares should be supported by the lower pound sterling. Overall, share valuations are moderately above fair value.
Similarly, Japanese shares are stronger due to a weak yen, and at fair value.
It’s only in emerging markets we can say shares look cheap, with prospects likely to improve across that region this year. Although we should note the risks US policy and currency pose.
Leaving shares aside, bonds will underperform as economic growth coincides with higher US bond yields, but will be limited by still high debt levels, easy monetary policy and moderate inflation. We are more constructive on the outlook for Australian fixed income as we expect the RBA to keep rates on hold narrowing the spread between Australian and US 10-year bond yields. Possible tightening of monetary policy in Europe could see bond yields shoot up.
Stewart Brentnall is the chief investment officer of ANZ Wealth. And Mark Rider is head of investment strategy and portfolio management.
The ANZ 2017 Global Market Outlook report outlines what ANZ Wealth’s investment managers expect in world economies and markets during the calendar year.