January 2018

Investment Strategy Update 

2017 proved to be a positive year for equity markets, reflecting in strong portfolio performance. Despite the belief that 2017 equity performances will be a tough act to follow as the business cycle matures, we expect the solid global economic backdrop to continue throughout 2018 and remain supportive of attractive risk-adjusted returns. The International Monetary Fund projects GDP growth of 3.70% in 2018 after expanding 3.60% in 2017.   

Below are a number of key themes that we are focusing on over the next quarter and throughout 2018.  

Theme 1: Normalisation of Federal Reserve Policy  

The strength of the US economy is generating upward pressure on the Federal Reserve to implement policy normalisation. In 2018, we see the US Federal Reserve likely to raise interest rates two or three times, while simultaneously continuing to shrink its balance sheet. We continue to believe this normalisation will result in a stronger USD/AUD, a view that failed to materialise in 2017.  

The announcement of US tax reforms should provide a boost to the US economy and equity markets as corporate America becomes more competitive with global peers whilst providing a major shift in the proposition of US corporate income retained domestically. We should also see lower tax rates provide incentives to corporations to invest in the US, resulting in increased wage growth and subsequently rising inflation. How the central bank responds to the re-emergence of inflation could be key to equity markets through 2018.  

With US Markets looking expensive we believe that a more active approach is necessary, with a focus on the technology sector where high levels of forecasted growth and cash flows.  

Theme 2: Building Asian Equity Allocations  

We continue to view Asia as a compelling investment opportunity. China and India together have a population of 2.7 billion and a land mass slightly smaller than the EU and US combined. Furthermore, their combined GDP of US$33 trillion is 50% larger than either the US or the EU. The region has become far more attractive for investors due to being less susceptible to shocks, the ability to side-step development hurdles and the region becoming less dependent on trade with the West.   

In China, the economy remains on track for 6.50% growth in 2018. Risks are quite balanced with deleveraging to be offset by increasing fixed asset investment and rising consumer spending. Consumer sentiment is at the highest level since the end of 1996 due to better labour market conditions and strong wage growth. Chinese markets could see large inflows in 2018 on the back of the formal inclusion of A-shares to MSCI indices providing and added tailwind.  

Steady growth, robust trade and commodity price stability should be supportive of Asian growth in 2018. We are very optimistic about the opportunities on offer in Asia and continue to build allocation within portfolios.  

Key Risks Ahead:  

  • The key risks going into to 2018 are as follows:  
  • How central banks responded to the re-emergence of inflation;  
  • A more protectionist US trade policy and changes to the North American Free Trade (NAFTA) agreement;  
  • Greater potential to return to normal levels of volatility;  
  • 2018 elections for Italy and Mexico;  
  • North Korea Nuclear program;  
  • Rising tension between Iran and Saudi Arabia.  

Portfolio Positioning:  

We believe that a solid economic backdrop and increasing corporate profitability should drive equity returns in 2018, yet stretched valuations mean that there is a growing importance for stock selection. Innovative companies with the potential to disrupt existing industries could fare particularly well and will therefore feature more in your investment portfolio.  

We continue to build our position in international equites whilst retaining high allocations to domestic equities. As outlined in our last update in November, we continue to believe that there is no point selling on suspicion while the market is rallying, rather we will wait for a weakness to occur and react appropriately rather than guess ahead of time.   

We remain aware of the risks ahead, and have positioned the portfolio to protect capital by having risk management processes in place and ensuring sufficient allocations to defensive assets such as fixed interest and cash.