Green light for 2018 share market
By Frank Jasper, Chief Investment Officer
11 December, 2017
It has been a wonderful year for markets and most investors will enjoy looking at their KiwiSaver balance or investment portfolios, which will look a lot healthier than they did at the start of 2017. Markets have been carried higher on the back of rosy economic growth, which for the first time since the Global Financial Crisis is showing coordinated strength all around the world.
For those of us who have been around for a few years while we enjoy strong markets there is always the question about whether they can continue and for how long. One of the frameworks we take into consideration in order to answer that question is our “traffic light indicator”, an assessment of the risks that typically point to market downturns.
The good news is that right now most potential risks that typically point to corrections are not that evident in markets. In fact we see plenty of green lights supporting continued healthy returns. There is only one key red light on the horizon, which while this is something we are monitoring, in our opinion it is unlikely to be enough to derail the strong run of markets into 2018.
The only red light we see is the level of debt that companies have right now. This is very high by historical standards. While this is of some concern, it is a logical outcome of the very low interest rates experienced since the Global Financial Crisis. Companies have taken advantage of this by borrowing money at low interest rates and buying back their own shares. This has been good for shareholders but could go awry if for some reason company earnings come under pressure or interest rates rise dramatically.
There are some things that are flashing amber. We are monitoring these closely to see if conditions deteriorate further but for now they would not stop us being comfortable owning shares. Top of the list of these concerns are equity valuations which are stretched, the fact that interest rates look to have bottomed and that investors on the whole seem too complacent. Complacency manifests itself in many ways including the lack of market volatility, which could signal investors increased willingness to take on more risk.
The reason we remain comfortable with the outlook for shares is many of the typical indicators of market stress are just not flashing any warnings whatsoever. There are plenty of green lights. Inflation is well and truly under control, economic momentum is strong, company profits are growing and wage demands are modest and not impacting profit margins. These measures all suggest a healthy outlook for 2018.
While our traffic light risk indicator system is no guarantee that markets will behave next year they certainly give me the confidence to face Xmas dinner without worrying about a financial market hangover from 2017. Now just need to avoid eating too much!