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Nine sharemarket trends for 2018

Photo of Geoff Wilson By Geoff Wilson

min read

Positive themes from this year likely to continue, despite geopolitical risks.

The election of US President Donald Trump in November 2016 has had a surprisingly positive effect on global markets and US shares have hit new highs in 2017, reflecting the market’s desensitisation to geopolitical risks. 

Despite several negative events weighing on the Australian sharemarket, the rebound of the mining sector, increased capital expenditure, the infrastructure boom and strong growth in China were positive themes to emerge in 2017 and we expect them to continue in the year ahead. Here are nine key themes.

1. Mining and mining services
Higher spot commodity prices created strong tailwinds for companies leveraged to the resources industry, which are now in the second phase of share price increases. 

During the September 2017 reporting season, mining and mining services sectors proved to be the standout performers, exceeding market expectations and delivering strong earnings growth. 

The most recent mining downturn, which bottomed about 18 months ago, lasted considerably longer than average. As a result, companies with excessive costs and debt have struggled, with many ultimately failing. 

In contrast, businesses able to withstand the prolonged downturn emerged well-positioned to benefit from the upward cycle. With strong balance sheets and earnings growth, companies with exposure to resources should continue to benefit from the prevailing conditions and grow earnings over the medium to long term. 

The rebound of mining and mining services bodes well for Western Australia’s mining-dominated economy, which is in the nascent stages of a new growth cycle as reflected by various macro-economic indicators.  

2. Capital expenditure and infrastructure boom 
During the last reporting season, the market reported its biggest upgrade to capital expenditure since the global financial crisis. This may suggest Australia is joining the global business investment recovery and has the potential to drive company earnings growth. 

New South Wales remains the key beneficiary of investment in infrastructure, which should see its economy outperform other states.

3. Passive proved popular 
The debate between passive (index) and active management has continued this year, with passive investment styles emerging as the popular choice. The performance of active versus passive managers has been cyclical over time and we believe the current rise of passive investing will be short lived.

We believe that true active investing is a superior investment approach and that boutique managers are better positioned to outperform the market. We are concerned about the significant liquidity risks from passive money held in open-ended equity trust structures – exchange-traded funds (ETFs). In the United States, ETFs have grown to US$4 trillion, or 16 per cent of the equity market. 

4. Love of LICs continues 
Listed investment companies (LICs) have continued to be popular among investors, particularly with Self-Managed Superannuation Funds. More than 100 LICs are now listed on ASX with a combined market capitalisation of $32.7 billion, with the LIC market continuing to grow strongly, increasing 13 per cent this year. 

Among other benefits, investors are attracted by LICs’ ability to pay fully franked dividends and the transparency and accountability offered by their corporate structure.

5. Beware of insider sales
The prudent investment lesson to “beware of insider sales” was reinforced by heighted levels of insider activity, with company directors selling at inflated prices in 2017. A company’s directors, particularly executive directors, typically have more insight into a business than anyone else in the market. We are usually sceptical when a board member sells down their position, as it can be a signal that the company’s share price is overvalued.

Recent research reinforces this investment lesson, with an analysis of director sales revealing that when management sold large parcels of shares, their companies underperformed the market by 14 per cent on average.
 
6. Value in the banks 
The implementation of the Federal Government’s bank tax followed by a failed levy by the South Australian State Government, significant noise in the lead-up to the Australian Prudential Regulatory Authority’s (APRA) definition of “unquestionably strong”, and scandals relating to alleged money laundering and interbank lending rate rigging, are all issues Australia’s largest banks have faced in 2017.

The major banks have been trading in negative territory as these issues have impacted share prices. Although Australia’s economy has been sluggish, we expect the banks’ earning season to provide a catalyst for revaluation, in particular National Australia Bank , Westpac and Commonwealth Bank.

7. Markets desensitised to geopolitical threats
During the year, tensions significantly escalated between the US and North Korea. Flouting international sanctions, North Korea has continued to pursue a nuclear weapons program and launched a series of provocative missile tests, including over Japan. Equity markets have been subdued in their response and persistent concerns of a military outcome on the Korean peninsula have failed to alarm investors.
 
In our view, if the present North Korea crisis had taken place 15 years or more ago, there would have been a very negative and sustained market reaction.

However, it seems investors worldwide are becoming increasingly desensitised to geopolitical risks as various events and situations, such as terrorist attacks, become increasingly common.

8. China growth strong
China’s economy surged in 2017, supported by government economic initiatives. With the large infrastructure spending expected to continue, China’s economy will continue to grow strongly in 2018 and this will have positive implications for the Australian economy. 

The recent spike in global commodity prices were a result of China’s supply-side reforms, which will continue over the next one to two years. These reforms, along with Chinese Government infrastructure investment, will increase demand for commodities and support prices over the medium term, both in Australia and globally.

9. Amazon threat overblown
Amazon’s impending arrival in Australia has overshadowed the retail sector this year. Although the potential threat has had an impact on retail companies’ share prices in 2017, we have already seen retailers invest and explore alternatives to drive efficiencies, customer experience and lower prices.

About the author

Geoff Wilson is the founder of Wilson Asset Management, a leading investment firm. Entities managed by Wilson Asset Management own shares in Commonwealth Bank, Westpac and National Australia Bank.

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