The ASX’s “sweet spot” of reasonable underlying economic growth, persistently low rates, and relatively attractive valuation will make Australian shares a better investment in 2018 than their more fancied US counterparts.
That’s the view of Macquarie’s head of macro research, Jason Todd, who is admirably confident that the strong trends of 2017 can extend for a further 12 months.
Australian shares will outperform Wall Street in 2018, reckons Macquarie’s Jason Todd. Photo:
“I don’t think the market is difficult to call right now,” Todd says. He points out that this time last year it was much more difficult to predict how the next 12 months would play out. The story of 2016 was the end of the deflationary scare and the start of what in 2017 has become the well entrenched synchronised global growth rebound. But back then it was unclear whether the economic uplift would hold, or whether the world could handle tighter monetary policy in the United States.
That all might sound dangerously like the kind of hubris that gets investors in trouble, but burnishing Todd’s credentials is that he did well picking how 2017 would unfold. He forecast this year would end with the benchmark ASX 200 sharemarket index at 5875 points. At the time of writing, it’s about 5950.
Which brings us to the next year forecast, and “we have much more clarity on where global growth is,” Todd says. “In fact, I think it’s just a continuation of what we have seen over the last 12 months”.
So after being whipped by Wall Street in 2017, does Todd believe the ASX will deliver more (in local currency and total return terms) for shareholders in 2018 than US equities?
“Yes, I do,” he shoots back. “The US is in a different phase of economic growth and on the monetary policy tightening side of things, and they are also in a different phase in a valuation perspective as well.”
Let’s hope he is right again, as the Macquarie strategist is predicting the ASX 200 will end next year at 6500 points, implying a capital return of over 9 per cent. Add in a dividend yield of 4.5 per cent and the total return for Australian shareholders from the index looks like 13-14 per cent. A healthy return indeed. Compare that to Deutsche Bank strategists’ forecasts of 6050 and Citi’s prediction of 6400, and you see that Macquarie is on the more optimistic side of consensus.
Todd’s more upbeat view is based on the belief that the local market is in a “sweet spot”, similar to where the US market was 18-24 months ago. That was before the Fed began to raise rates; before there was any hint of wage increases putting pressure on company profits; and when the full benefits of a lower currency were flowing through to earnings.
“The key issue for us is that we have a slight improvement in economic growth, no inflationary pressures – which puts the RBA on hold – and so you have got this very nice backdrop that can actually continue to drive a lot of the trends in terms of what has performed and what hasn’t performed in the domestic equity market, and keeps it going for some time.”
“I think that there is too much emphasis on higher rates as a risk for the market,” Todd adds.
Todd points to business survey data which shows profit expectations are at 20-year highs, even as earnings expectations for ASX-listed companies have continued to fall. This historical correlation should reassert itself, Todd believes, allowing some “incremental” improvement in earnings growth.
“By and large I think that profit conditions for Australian corporates are pretty good – there is no real cost pressures coming through,” he says. And with Australian businesses running lean operations, “you only need a little turn in the sales line” to see a relatively large pick-up in earnings.
Todd’s preferred way to play these trends is to overweight domestic cyclical businesses as well as companies exposed to the solid offshore growth dynamic. He believes the infrastructure spending thematic “has longevity”, and likes Adelaide Brighton and Downer EDI. For the offshore play, he likes Boral and James Hardie for their exposures to the US home building cycle. He also picks Incitec Pivot for its “broad upside in industrial activity via soft commodities”. A period of Australian dollar weakness next year would be a “cherry on top” for stocks with overseas operations.
While some investors may be tempted to “bottom fish” the embattled retail and retail-related listed property plays, Todd is happy to stay on the sidelines. “I think you are going to be fighting this all these mini-cycles in the consumer area where the structural trend is still down,” he says. Instead he prefers online plays such as Seek.