A Review of 2017

For investors globally, 2017 has been a strikingly positive year. The US S&P500 Index finished the year up over 20%, its best performance in 4-years, while in New Zealand, our S&P/NZX50 Index rallied 22%. Some of the Emerging Markets are also worth mentioning with Brazil up 27%, Hong Kong up 36% and Vietnam’s Hanoi 30 rallying a massive 47%! Central banks around the world will look with satisfaction at the positive impact that their accommodative monetary policy have had as share market strength was driven by a backdrop of synchronised economic growth and rising confidence. The shadow of the GFC has certainly receded.

The year also had its fair share of challenges, with the world carefully following the machinations of the North Korean regime and the re-emergence of global populism. Manifestations of the latter included Trump’s first year at the helm of US politics, Britain’s ongoing deliberations around Brexit, and a number of Eurosceptic election results. Despite these distractions the US S&P500 Index, for the first time in history, generated a positive total return in every single month of the year with December recording the 14th consecutive month of gains. During 2017 the US Dow Jones Index (another major index similar to the S&P 500) also hit over 70 new record highs, which was the most record closes for a year ever, surpassing the previous record of 69 made in 1995. It was also a year in which many forecasters had expected to see a large lift in market volatility due to the perceived geo-political risks and the risk of inflationary pressures but the reality was quite different. In fact, as the year drew to its conclusion, it was the extreme lack of volatility that had many commentators most surprised. The S&P500 Index for example hasn’t suffered a 3% pullback, over one or multiple days, since before the US election in November 2016, its longest run on record.

Despite volatility remaining practically non-existent across many markets, not all assets behaved in an understandable fashion. This year will also be remembered for the performance of the cryptocurrencies. They became household topics of conversation as the likes of Bitcoin and Ethereum hurtled thousands of percent higher although it is worth noting that as the year drew to a close many of them faced a massive wave of selling. It is anybody’s guess how these currencies will perform in 2018.

On a more fundamental note, the Federal Reserve delivered on their three-rate-hike promise during the year, with another three forecast for 2018. The currently low US inflation rate has given the Fed the luxury of being able to move cautiously but their own projections are for the median federal funds rate to be at 2.1% by the end of 2018. This is more aggressive than the market continues to forecast and it is this dislocation (between the views of investors and the US Central Bank) that is at the core of the different possible stock and bond market outcomes that we could see next year. Inflation remained stubbornly subdued during 2017 but with unemployment levels continuing to fall and wage growth picking up, it is likely that any evidence of surprise here (with inflation rising more quickly than expected) would prove problematic for asset pricing across the board. Regardless of this, the Fed has led other global central banks in shifting away from extreme monetary policy settings by hiking interest rates and starting the process of balance sheet reduction. This was a major change in 2017 and its progression during next year will be carefully watched by investors.

Closer to home, 2017 proved to be a fascinating time for the New Zealand stock market. Although the headline performance of our major index (the NZX50) was impressive, what was extraordinary was the performance of some of our “less traditional” New Zealand businesses. The most extreme example of this was A2Milk which finished the year up 279% and is now our 5^th largest listed company behind Fisher and Paykel Healthcare, Auckland Airport, Meridian Energy and Spark. Other great performances came from Pushpay and Xero, although in the latter case the biggest news surrounding this accounting software business was its intention to delist from our local market and exclusively have its shares quoted in Australia. The rationale behind this decision is even today difficult to understand but we hope, for the sake of our capital market, that this is not the beginning of a trend. As we move into 2018 investors in the New Zealand market will need to contend with a new government and an index which is priced at a large premium to its history (on a market capitalisation weighted basis UBS believes the NZX50 Index is now trading at a P/E greater than 22-times!). With economic growth likely to slow over the next 12-months due to tighter immigration policy and a potentially softer property market, the current valuation of our local share market may be difficult to sustain.

In Australia, the overall ASX200 Index delivered a total return during the year of 11.8%. This was a notably softer than the New Zealand market but there were some interesting contributions within the overall result. Resource and Mining companies were among the best performers with strong global growth driving up demand from these Australian businesses while some of the worst performers included those exposed to the Retail sector. The arrival of Amazon to Australia in December has created an enormous level of uncertainty around the sustainability of many of these companies and investors took a conservative approach in pricing these stocks during the year. Outside of the LNG sector, the Australian economy is not expected to deliver many positive surprises in 2018 with the consumer remaining cautious due to low wage growth and an extended balance sheet.

Overall 2017 was a year that caught many global investors by surprise. The power of easy policy conditions and some fiscal initiatives in the fourth-quarter created a very favourable framework for equities. As we move into the New Year, the key issues to watch will revolve around inflation, the ability of central banks to execute the normalisation of policy and the levels by which corporate profitability can continue to grow. Volatility across markets will almost certainly lift from current levels and as such the opportunity for active investment management should improve.