Has the Australian share market had a good year? Well, not that bad if you were to judge solely on the performance of the S&P/ASX 200 Index, which was up 7.0%. But while that sounds like an ok return, there are a couple of things that should be considered.
One is that if dividends are counted – as in the S&P/ASX 200 Total Return Index – the share market’s return looks a whole lot better, at 11.8%.
The second is that given everything that has been thrown at the share market in 2016, this rise is a decent effort.
Share markets started 2016 immediately behind the eight ball, as concerns over weakening global growth turned into fears of recession. Markets were spooked by plunging stock prices in China and the meltdown in oil prices. While many Australians relaxed at the beach, on Wall Street, the Dow Jones Industrial Average got off to its worst-ever performance over the first 10 trading days of the year.
Less than a fortnight into 2016, most major world markets were officially in “correction” territory – that is, down at least 10%. The Chinese market officially entered a full-blown “bear market” – down 20% plus – within a fortnight of the New Year starting.
Australia’s took a bit longer to follow suit but the S&P/ASX 200 index was down 11.1% less than six weeks into the year.
At one point in January, crude oil was down an eye-watering 28% to a 12-year low of US$26 a barrel. The fear at the time was that the oil slump indicated weak economic activity and shrinking world trade.
An extraordinary strategy note issued in early January by the Royal Bank of Scotland (RBS), saying it was time to “sell everything”, did not help the markets’ mood. RBS warned in the note of a “cataclysmic year” ahead for markets, and advised clients to “sell everything except high-quality bonds.”
But seemingly from nowhere, a mid-February rally brought some respite. Desperate for good news, markets seized upon developments in the commodities markets. First, the United Arab Emirates (UAE) energy minister said that Organisation of the Petroleum Exporting Countries (OPEC) members might be ready to co-operate to curb crude oil output. Suddenly, oil prices rose 10%.
Then China, the world’s biggest steel producer, announced that it would close between 100 million and 150 million tonnes of annual crude steel capacity by 2020, as much as 13% of existing capacity, sparking a rebound in iron ore and coking (steelmaking) prices. The People’s Bank of China (PBOC) and the European Central Bank (ECB) both said they were ready to step up stimulus measures, and confidence seemed to return as quickly as it had evaporated.
The markets took heart in March from a surge in US hiring and economic growth, and some even moved into the positive for 2016. Oil prices continued to recover in April, and the world was suddenly in a commodities recovery. Led by the bulk commodities, iron ore and coal, Chinese construction activity picked up on the back of the government and central bank, and the country closed much of its own unprofitable capacity.
Brexit blues
Towards mid-year, the stock markets began to fixate on “Brexit” in the lead-up to the referendum on the United Kingdom’s European Union (EU) membership. Britain’s eventual vote to leave the EU stunned the markets, and in what became a dress rehearsal for the Trump election in the US in November, the gyrations were spectacular.
As the referendum result became known, the UK pound plunged 11.3%, from US$1.50 to $1.33, a level not seen since 1985. The FTSE 100 Index dropped 8.7% in response, as London Stock Exchange trading volumes hit an all-time high, and European markets suffered similar falls. In the US, the S&P 500 shed 3.6%, while the Dow Jones Industrial Average lost 3.4% – virtually erasing the year’s gains – and the Nasdaq Composite Index lost 4.1%, its worst fall since 2011.
But by July, markets were asking, “Brexit … what Brexit?” as the month brought strong rises despite the UK vote, Japanese stimulus that failed to stimulate growth and the revealing of weak US second-quarter economic growth.
Markets dozed through the holiday month of August, despite the amazing news that there were now about US$13.5 trillion of global bonds offering negative yields, compared with barely any with a negative yield in mid-2014. September brought news that OPEC would limit production to 32.5 million barrels a day, representing the organisation’s first output cut in eight years. But by October, markets were paralysed by the impending US election.
Stock markets get Trumped
The tightening of the Presidential race helped to tip the US indices to an October fall, as the political uncertainty over-shadowed improving US economic data. The US economy grew a stronger-than-expected 2.9% in the third quarter, and consumer spending, which accounts for about 70% of US economic activity, rose more than expected in September. Chinese economic indicators also improved.
As the US vote was tallied, and it became clear that Trump had won, the futures market versions of the Dow Jones Industrial Average, S&P500 and Nasdaq Composite indices each fell 4.5%–4.6%, almost reaching the maximum allowable futures-market falls. On election night itself, noting these falls, eminent US economist Paul Krugman opined that markets would “never recover.” Fortunately, for panicked investors, the US markets actually rose the next day, helping the S&P 500 gain 3.7% in November, and 10.2% for the year to date (to 14 December). With January a distant memory, the three major US indices all made record highs in December.
Commodities charge ignites markets
China’s efforts to stimulate its economy in 2016 flowed through to strong gains for the major metals commodities, helped by steady improvement in investor sentiment – if you discount the short panics accompanying the Brexit vote and Trump win – and speculation on the Chinese futures markets.
Commodities have pulled off a Lazarus-like comeback this year, led by the bulk commodity trio of iron ore, coking coal and thermal (electricity) coal.
Against virtually all predictions, coking coal has risen almost five-fold this year, from US$78.20 a tonne to US$308.80, while thermal coal is up 92% to US$107.24. These are levels not seen since Queensland’s 2011 floods shut export mines.
For its part, iron ore has doubled in 2016, reaching a high of $US80 a tonne.
Outweighed little end of market roars
These rises helped to explain the gain in the S&P/ASX 200 index – the Materials Index was up 42.9% in 2016, almost two and a half times the rise of the next best performer, Utilities. And because Materials is presently the second-largest weighting in the index, accounting for 16.2%, its impetus has been the difference – given that the largest weighting, Financials, at 38.2% of the Index, has under-performed the market, gaining 10.2%.
On the capitalisation front, the S&P/ASX Emerging Companies index (covering the “micro-cap” stocks in the Australian market) and the S&P/ASX MidCap 50 index (comprising all the members of the S&P/ASX 100, except those in the S&P/ASX 50) have been the strongest performers, up 24.6% and 17.8% respectively. In contrast, the S&P/ASX 20, which covers the 20 largest stocks and represents 46% of total market capitalisation, is up by 8.8%.
The lessons of 2016
Peter Switzer, economist and co-founder of the Switzer Super Report, says he was surprised by the excessive sell off that kicked off the year. “At the time, my economic outlook was for growth in Australia and in the US, China was a question mark but the government was spending, and Japan and Europe were trying to stimulate,” he says.
But if that sell off was surprising, the subsequent commodity price recovery was stunning. “We’ve gone from a complete bear market in resources to a full-scale bull market in the space of 10 months,” says Charlie Aitken, chief investment officer and founder of Aitken Investment Management.
“If you’d told me in January that you’d make 300% in Fortescue and South32 and 100% in BHP, I would not have believed that – and I certainly wouldn’t have believed it in early February when they went lower. That has been truly amazing.”
Aitken says the market simply got “way too bearish” at the bottom. “People started cutting supply, marginal producers were cut out, and then demand from China picked up after Beijing’s infrastructure spending stimulus. Everyone under-estimated the demand recovery from China,” he says.
The UK’s Brexit vote was an “obvious shock,” as was Donald Trump’s presidential election win, says Switzer. “They were unexpected results, the markets fell dramatically in response to them, but then recovered just as dramatically.”
Paul Rickard, co-founder of Switzer Super Report, says 2016 was a tale of two halves, with interest-rate defensive sectors and healthcare running hard in the first half, and financials, energy and resources “on the nose” – but a straight reversal in the second half. This turnaround demonstrated yet again the importance of diversification, he says.
What to expect in 2017
Switzer is confident that the Trump rally – which has pushed the S&P 500 Index more than 10% higher since the November US election – can continue into 2017. “Eventually there will be a sell off, because it has run up pretty quickly. But I think that would represent another buying opportunity. Even the rise in interest rates – only the second in the last 10 years – was seen by many as a reaction to stronger US economic performance,” he says.
Had Hillary Clinton won, Switzer would still have said 2017 would be a better year for the US economy and earnings. “We were already set for stocks to go higher, but you then get this Trump effect turbocharging the markets. Into 2017, if investors get more convinced about the earnings outlook for the whole market, and get more positive that fundamentals are genuinely improving, the US market should move higher,” he says.
That US market strength will drive the Australian market, says Switzer. “I think we’ll see 6000 points on the S&P/ASX 200 Index”.
Aitken believes this bull market will extend into 2017 because we’re seeing a clear leadership change from America. “We’re seeing a massive leadership change from defensive stocks to cyclical stocks, and money is moving out of the bond market into equities. We’re seeing a bullish rotation from defensive assets and bonds to value and cyclical stocks. It’s happening in Australia too, and that’s very good for the banks,” he says.
Outlook for income stocks
Rickard says banks should remain the focus of income portfolios, despite analysts’ expectations of slight dividend cuts from Westpac, CBA and NAB in FY17 and FY18.
“If you want income stocks, you’ve got to go for quality. The banks are still yielding in the 5.2%–6.2% range, which, with franking, becomes 7.4%–8.9%.
“Likewise, Telstra, is expected to yield 6.3% in FY17 and FY18, which, with franking is 9.0%” says Rickard. “Yield-hunters find it difficult to go past these kinds of stocks.”
Switzer says there are plenty of good-quality stocks where if the share price falls and drives the yield up to 5%–6%, “they’re the sorts of things I’m going to be looking for.”
How to play 2017
At the moment, the large-cap stocks are leading the market, and Switzer says the fundamentals are definitely improving for them, so that move has longer to play out.
When investors get more confident in the improving earnings picture, he says they will be prepared to move into the mid-cap and even small-cap space.
Sectorally, Switzer says the banks will remain strong in 2017, and he would also look to high-quality healthcare names such as CSL, Ramsay Health Care (RHC) and Cochlear (COH), as contrarian plays.
Rickard agrees, arguing that Australian institutions are following their US counterparts out of healthcare stocks. But the strong thematic driver of ageing populations in the developed world and increasing spending on healthcare remains intact.
“With the healthcare sector out of favour on the market, for whatever reason, stocks like CSL are in the buy zone,” he says.
“They’re great companies: sometimes I think you’ve got to buy when others want to sell.”
Aitken is most bullish on the Australian outdoor advertising sector for 2017 and beyond. His fund has large investments in the two major players in the sector, APN Outdoor (APO) and oOh!media (OML), who announced a merger in December 2016.
“The outdoor advertising segment is growing at double digits, and it’s a classic example of an investment idea you can see with your own eyes in everyday life,” he says.
Sectors that Rickard does not like for 2017 are the real estate investment trusts (REITs), and the consumer staples sector, where competition is only heating up. And after the massive resources rally, Rickard says the best of that move has already happened – but investors who are set in resources should let it run.
If you’d like to find out more about the stocks the experts will be watching in 2017, read our eBook 10 Stocks to buy in 2017 today.
Data sources: FNArena, Investing.com, Financial Times
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
