Australian equities set for strong 2018

12 Dec 2017

The Australian share market could rise by nine per cent in 2018, with Australian equities set to capitalise on similar conditions to those experienced in the US over the past 12 to 18 months.

Macquarie Group Head of Australian Equity Strategy, Jason Todd, says one of the most encouraging signs for Australian equities is the steepness of Australia's bond yield curve.

“Historically, the yield curve has been a good indicator of what to expect," Todd explains. “After past six or seven years of almost no movement, long yields are rising while short yields stay low. This is known as a steepening of the curve."

Todd says this usually indicates an economy is entering the recovery phase, where the market expects stronger economic growth, eventually leading to higher wages and inflation.

As federal banks raise interest rates to counter this, the yield curve flattens and the economy enters the next phase of the yield cycle.

“Historically, the expansionary phase of the economic cycle, when the curve is flattening, has been associated with the strongest period of equity market returns," Todd says.

Todd doesn't expect that to happen in Australia until late 2018, about 18 months after the Federal Reserve lifted rates in the US.

Another area where Australia seems to be catching up to the US market is in the growing investor appetite for higher price to earnings ratios, which barely changed over 2017.

There has been a lot of focus on Amazon's entry into the Australian market, but Amazon isn't the story. Technology is the story. Its influence will grow exponentially over 2018.

“Australia has traditionally been a value driven market," Todd says only a few areas of the market appear overvalued. The overall Australian market is not expensive and some industries - such as telecommunications, healthcare and utilities - remain cheap but without much earnings support.

He expects further multiple expansion in 2018, with a one per cent rise in PE ratios to 17x putting upward pressure on share prices.

Todd also believes automation and technological change will continue to have an impact in 2018.

“There has been a lot of focus on Amazon's entry into the Australian market, but Amazon isn't the story. Technology is the story. Its influence will grow exponentially over 2018."

Todd says Australia is at the beginning of a long technology-driven period of upheaval which will spread across the entire economy.

“The starting point has usually been to look at which industries technology will disrupt. We assume almost everything will be disrupted. If there are excess margins in any industry, technology will be one of the factors that potentially erode them."

Todd expects shareholder activism and scrutiny of capital management to play a bigger role in 2018.

 “In all, we have the potential for strong growth, no inflationary pressures and profit conditions at 20-year highs," Todd concludes. “Plus the Australian market rose by 15 per cent last year despite most people's expectations.

“This is similar to where the US was just over a year ago, so I think a lot of people's expectations are too low."

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