Outlook: Ryan Felsman

After a year of near-record local returns, trade issues could spoil the party

The financial year has just concluded and Aussie sharemarket investors have plenty to smile about. Total returns on the ASX All Ordinaries accumulation index, which includes dividends, surged by 13.7% over 2017-18, just short of record highs.

The performance of Aussie equities was the strongest in four years, outperforming both residential property (up 2.7%) and government bonds (up 3.1%). An investor who employed a diversified strategy across asset classes would be well pleased with the performance over the past year. But will it continue?

Certainly, Aussie economic and financial metrics remain encouraging. Australia has underlying inflation below the Reserve Bank’s 2%-3% target band at 1.9%. Economic growth is lifting (at 3.1%) with quarterly growth in the March quarter the fastest in six years. Business conditions are just below 20-year highs. The cash rate remains at record lows. And unemployment is at a five-year low of 5.4%.

While housing and infrastructure activity have driven the economy over the past year, in the year ahead exports and business investment are expected to play bigger roles.

The Reserve Bank appears to be relatively comfortable with how the current rebalancing of the housing market, on the back of macro-prudential policy, is playing out. And while prices are falling, the declines need to be put into perspective given the very strong gains experienced since early 2012.

Over the coming year, more and more apartments will be completed with more stock hitting the market. It has taken a little longer than expected but supply and demand for homes are likely to prove more balanced, restraining growth in prices.

Looking ahead, we think dwelling prices will continue to drift lower. We expect them to fall around 2.5% this year, with a similar-sized fall next year as well. The declines are likely to be concentrated in Sydney and Melbourne, and partly offset by a pick-up elsewhere.

Inflation remains subdued due to stilllow wages growth, which is only expected to strengthen gradually. And intense supermarket competition and significant online competition are squeezing retailers’ margins. We see inflation eventually lifting to around 2%-2.5% cent by mid-2019. The Aussie dollar is forecast to trade in the mid to late 70s against the US dollar over most of the coming year.

After a period of abnormally low market volatility due to accommodative central bank policy support, investors are now experiencing more turbulence in financial markets. As the year develops, there will also be more debate about interest rates in the US and how close the federal funds rate is to the “neutral” level.

As US rates approach the “neutral” level, the greenback is expected to start losing some of its strength, providing a boost to exports and broader economic growth. However, the “sugar hit” from the Trump administration’s $US1.5 trillion ($2 trillion) corporate tax cut is likely to fade into 2020.

Trade issues are likely to dominate over the coming year, driven by concerns in the US about “fairness”, particularly about intellectual property and auto protectionism. While the direct impact of the already implemented tariff measures on global economic growth is likely to be modest for now, a further escalation may adversely impact business confidence, lift producer prices and tighten financial conditions.

Elections to watch include the Australian federal election, NSW and Victorian state elections and the mid-term US elections in November. The Italian budget poses a risk to markets in September, while disagreements in the German coalition government may continue.

Here in Australia, the low inflation and interest rate environment remains entrenched for now, meaning that lower nominal investment returns are also here to stay. This means investors will need to remain flexible and alert to the returns achieved across sharemarket sectors and across asset classes to ensure that their savings are keeping pace with costof-living increases.

Falling house prices need to be put into perspective given the very strong gains since early 2012