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Will the bull market end?

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While still well below its own pre-GFC peaks, the ASX played catch-up in the final quarter of the year, surpassing the 6,000 point mark and is now trading near a 10 year high. Markets from New York to London have reached fresh all-time highs in 2017 and emerging markets have also posted strong gains, especially in the second half of the calendar year.

Is the ASX in a sweet spot or subject to elevated risks? We will look some of the most important topics for 2018 – including the US, monetary policies, geopolitical risks and Bitcoin - and discuss how these issues might influence global equity market dynamics.  

Stocks are cyclical: Will the bull market end?

U.S. stocks have been in a bull market since the end of the Global Financial Crisis of 2008/2009. To put this into perspective, the value of the U.S. stock market has appreciated for nearly nine straight years  without a decline of 20% or more. That’s quite remarkable considering that we have had to combat several challenges including the European sovereign debt crisis of 2008-2011, Brexit, the collapse in global oil prices, an economic slowdown in China, terror attacks and geopolitical tensions with North Korea and in the Middle East. In addition, the U.S. national debt has doubled to over US$20 trillion during this bull market.

A bull market is characterised by market confidence and upwards price movements, often in a self-sustaining manner. The S&P 500 has more than tripled since hitting a low in February 2009, propelled higher by loose monetary of the Federal Reserve Bank through the introduction of quantitative easing and record low interest rates. As we know, stock markets move in cycles and every bull market will eventually come to an end – the question is when?

The next correction may not be as severe as the GFC but eventually valuations will have to come back to their long-term average, which we regard as positive for the sustainability of the global financial system. History has taught us that inflated prices are a major risk for individuals as well as the system as a whole. ‘Economics 101’ teaches us to ‘buy low and sell high’ but the theme of the past few years has been to ‘buy high and cross your fingers’. Investors are paying a very high price for the risk that they are taking.

Economic expansion on track

Global economic expansion and subsequent earnings growth is largely on track as most parts of the world experience modest growth. However, it is our belief that the market has already factored this in – which means any changes in the current assumptions will likely impact investor sentiment towards stocks.

The European economy is strengthening and with the eurozone recovery at an early stage of the economic cycle after several years of struggles, there is potential upside for equities over the long-term.

The global economy remains heavily reliant on China and there is a risk that an economic slowdown may impact stock prices. On the other end, sustained economic expansion and ‘faster than expected’ growth could offer ongoing support for stocks.

The price of money - interest rates set to rise

It is the common belief that the U.S. Federal Reserve will continue to lift borrowing rates over the course of the year, probably two or three times. At the same time the European Central Bank plans to scale back its quantitative easing program. However, scaling back bond purchases and introducing tighter monetary policy is a delicate operation.

While economic developments may alter policy decisions, it is almost certain that central banks will provide less stimulus to markets and the economy. This is good news.

Confidence in the global economy and its ability to stand on its own feet is rising. The exit from cheap money will be gradual and ‘soft’ – if everything goes according to plan. The availability of cheap money is a high risk and frankly needs to end: it has negative implications on savers and supports ‘zombie’ companies.  

So far stocks have shaken off the shift towards tighter policies, but there is no guarantee that it will continue to be that way. Central banks will certainly try to avoid a hard landing. Australian savers may even be able to eye a lift in borrowing rates towards the latter part of the year.

Property market set to cool further?

Betting against property prices would have been a poor move at any point in the past decade, especially in Australia’s metropolitan cities. We’re admittedly no experts in property but a number of trends will likely impact the Australian property market in 2018. For starters, there is a real chance that the Reserve Bank of Australia may lift the official cash rate, or at least keep it steady, which could translate into higher mortgage rates. House prices in Australia’s hottest markets - Sydney and Melbourne - have switched gear in 2017 and a continuation of the cooling housing market is possible.

The stock market may be impacted in a number of ways - REITS may underperform and investor appetite for stocks in general could increase if less growth is realised in property. The outlook is mixed at best, but we believe a cooling housing market should have a net positive impact on Australia, as long as prices don’t decline sharply.

Ethical investing will continue to gain popularity

Wise-owl is a strong supporter of ethical and sustainable behaviour, both in business and beyond. Ethical investing describes an investment process that incorporates environmental and social factors when selecting investments, in addition to the objective of achieving a competitive financial return. Operating a business in an ethical and sustainable way is a necessity for long-term wealth creation – anything else would be like betting on something you know will eventually collapse, which is madness.

Being an ethical investor has nothing to do with being ‘good’ or ‘bad’ – it simply means being smart. Invest in companies with a future, a responsible product and a capable and ethical management team. Why would you invest your hard-earned cash in companies that actively promote health damage or underpay staff?

According to research compiled by Wise-owl, ethical investments have outperformed many other investment classes. No need to sacrifice performance for the sake of ethics.

Geopolitical risks a persistent threat

While the global economic outlook is improving, we know that geopolitical risks have the potential to generate volatility (which is by the way near an all-time low). The conflict between the US and North Korea is far from over and there is a risk that either Trump or Kim Jong-Un may flex their muscles again.

We also see general risks associated with policies of the Trump administration. Global equity markets have welcomed Trump’s policies to date, but further diplomatic disputes remain a persistent threat.

Risk and instability in the Middle East and North Africa remain a threat, especially as stocks are arguably ‘priced to perfection’ and any disruption could have a significant impact.

Small and mid-caps to outperform?

Over the first nine months of the year, small-caps failed to generate shareholder value and in fact underperformed large-caps. However, the Small Ordinaries – which includes the mid-cap companies of the ASX 300 outperformed in the final quarter of 2017. The Small Ordinaries gained 16% in 2017 which compares to a 7% return for the ASX 200 (excluding dividends).

Where will investors look for value in 2018? Are banks and large resource stocks still attractive? It is Wise-owl’s belief that there are a number of attractive small and mid-cap investment opportunities and investors will seek growth in these companies, which will drive the performance of small-caps.

Bitcoin: Bubble or long-term value?

After Bitcoin’s meteoric rise in 2017, the question that everyone is asking is whether the bubble is about to burst. But maybe the critics are getting it all wrong and cryptocurrencies will experience price stability over the course of next year. This discussion does not only apply to Bitcoin but arguably for all cryptocurrencies.

With volatility being the norm, the question is whether a mass of new investors, attracted by this year’s massive price run-up, will stick with Bitcoin through short-term losses or if everyone is heading for the door. Bitcoin may not impact the greater landscape of stocks, but it will certainly be an asset class to watch in 2018.

Wise-owl has no particular view on Bitcoin, but we see significant value in blockchain technology as it can transform the financial industry and the way we transact. It wasn’t until 2017 that Bitcoin hit a tipping point of mainstream popularity, but it remains to be seen if its general acceptance will grow or vanish in 2018.

We see value in moving towards a cashless society over time and maybe digital currencies can help humanity get there. However, from an investment point of view, it is hard to justify and explain the significant price appreciation in cryptocurrencies.

One thing is clear: currencies aren’t meant to be in bull markets forever. The value of a currency is relative to the strength of another currency, and thus fluctuates over time.

Final note

Conclusively, investors must be aware of the risks they are taking and factor them into their decision-making process. There are certain stocks and sectors that have reasonable value and growth potential, and others that should be avoided. Nobody knows exactly how global equities will perform, but we believe it makes sense to be optimistic whilst somewhat cautious.

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Simon Herrmann is an equity analyst at Wise-owl. This information was produced by Pty Ltd (ACN 097 446 369), which is an Australian financial services licensee (Licence no. 246670). This material is intended to provide general advice only. It has been prepared without having regarded to or taking into account any particular investor’s objectives, financial situation and/or needs. All investors should therefore consider the appropriateness of the advice, in light of their own objectives, financial situation and/or needs, before acting on the advice. This article does not reflect the views of nabtrade.