Will the investment cycle end soon?

24 January 2018

House View

The strong investment growth of 2017 is unlikely to be repeated, explains chief investment officer Mark Rider.

Last year was a strong one for sharemarkets, which delivered double-digit returns for investors. The challenge for 2018 is, will this continue? And if so, how long can this all last?

Strong investment market performance is not unusual as the end of an investment cycle nears. (Markets in 2017 were also boosted by low interest rates and easy financial conditions.)

ANZ’s chief investment office envisages 2018 to be more of the same in terms of economic growth, but as we start the new year, some of the key indicators are starting to wane.

Rising risks

The indicators we’ve been monitoring – such as the US yield curve (which shows the difference between the yield on the 10-year Treasury bond and the 2-year Treasury bond) – are starting to shift from the “green zone” to amber and this suggest greater need for caution. And when that gap turns negative, it could signal that the current investment cycle is coming to an end.

While that indicator is one to watch, the key challenge we see in 2018 is the outlook for wages and inflation, particularly in the US.

The US economy is at full capacity already. And with the US unemployment rate set to fall below 4 per cent this year, this could mean wages are about to rise.

If wages rise more rapidly than anticipated, we may see the US central bank increase rates faster than it otherwise would – bearing in mind there are already three rate rises expected in 2018.

The problem with additional US rate increases is that other central banks may join the US in synchronised policy tightening.

Already the European Central Bank has stated it would reduce the amount of bonds it purchases from this month.

Other key central banks are also gradually reining in the accommodative monetary policy that has been in place since the global financial crisis, which has arguably been a strong force behind the sharemarket rallies in recent years.

In 2017, economies and financial markets were largely insulated from rising political risk, possibly due to stronger growth and easy monetary policy.

This could change in 2018 as firmer central bank policy creates a more fertile environment for political risk to become a driver.

Add to these risks the conundrum that China is in as it attempts to tighten financial conditions and create a more sustainable future for its economy.

Growth assets still in favour

While we’re mindful of these challenges, we expect the environment will continue to favour growth over defensive assets in 2018. But the investment cycle will face greater challenge this year, and any of the risk factors outlined above could change market dynamics, potentially bringing it to an end.

Therefore, balancing growth expectations with emerging risks, we maintain a neutral stance on shares and all growth assets. We’ll be keeping a close watch on our key indicators: history suggests that if wages and inflation lift even slightly faster than currently factored into financial markets, amber signals can shift to red – which may signal the need for a more conservative approach.

Investment positions at January 2018

Asset class Position relative to benchmark/outlook1
Growth assets Neutral
Australian equities Neutral
International equities Neutral
  - United States Neutral
  - Europe Neutral
  - Japan Neutral
  - emerging markets Neutral
Listed real assets2 Neutral
Defensive assets Neutral
Fixed income Underweight
  - Australian Neutral
  - New Zealand Neutral
  - International Underweight
Cash3 Overweight
AUD/USD Neutral
NZD/USD Neutral
USD TWI Neutral

1. Equities, fixed income and cash are relative to benchmark. Currencies are relative to an absolute return outlook (short term).
2. Comprises of 50/50 split between GREITs and infrastructure securities.
3. Cash is the balancing asset class.

Read the full Chief Investment Office House View.

January 2018