Each year I outline how I think the Australian Stock Market might fare bearing in mind that my forecast, like all forecasts, is actually a calculated guesstimate – at best. None of us know with any certainty how the financial markets will ride out the year and it’s probably a safe assumption that anyone that implies that they do is either trying to sell you a book or website subscription. But a forecast can be a useful planning exercise even if it simply makes us think of the factors that might move the markets. So once again I will go out on a limb and add my forecast to the galaxy of other forecasts.
Usually I attempt to get my forecast together in January or February, but this year it’s been quite difficult to try and factor in developments like Brexit and Donald Trump sitting in the Oval Office. To complicate matters further there is the ongoing and seemingly never-ending debate about home prices in Australia and various geopolitical issues on the horizon to deal with. In truth we always live in somewhat uncertain times but the market outlook for 2017 appears to be a little more uncertain than in recent years. As I will discuss later, there are reasons to be optimistic about the outlook for Australian stocks this year and yet I feel the S&P/ASX 200 will struggle to hold onto the gains made during the “Trump Rally”.
On the positive side the Australian economy is still in the midst of a recession free era with the unemployment rate relatively low, growth moderate and export earnings holding up fairly well. In terms of stock market performance, the S&P/ASX 200 whilst still a laggard when compared to the Dow Jones Industrial Average (DJIA), is heading towards 6000 and many commentators believe this is just the start of a major bull market run that might even see it finally reach the pre GFC highs within 2017. Certainly if we look at the 1 year (candlestick) chart of the ASX 200 it does appear that the bulls are control.
S&P/ASX 200 Index (XJO) 1 Year Chart
Around 12 months ago the ASX 200 was below 5000 and it has since risen by 1000 points or about 20%. That’s quite a good gain if as an investor you had got the timing just right and bought on or near the low and was prepared to sell now. But if we step back and take the longer term view things look very different.
S&P/ASX 200 Index (XJO) 5 Year Chart
In the chart above the recent rise of the ASX 200 is put into some perspective. We have seen similar rallies before and yet the market is still below the pre-GFC high back in 2007 of around 6,800. This means that it’s quite likely that after 10 years the Australian stock market will still be trading at a level lower than it was trading around back in 2007. That’s not really my idea of a stellar bull run and my view is that the market is still struggling as I have written about on several occasions. That does not mean it’s not worth investing in ASX listed stocks or funds since there are certainly stocks and funds that have done very well. But I simply urge investors to be cautious and not get carried away by much of the hype and click-bait articles that dominate much of the finance media. Next let’s look at the overall long term trend for the ASX 200.
S&P/ASX 200 Index (XJO) – 1992 – 2017
I have used a long term chart of the ASX 200 before to show trend lines and trading lines as I believe it’s a useful way to keep the big picture view in our minds. For example the performance of the stock market should over the longer term correlate to some extent to how the overall economy is performing. Thus if the Australian economy is expanding we would expect the stock market to be rising along with this expansion. As shown in the chart above the overall trend for the ASX has been upwards and it appears now that it now moving upwards along a trend-line consistent to the trend before the pre-GFC/commodities boom. This is a good sign and some would say that this is an indication that the market has reverted to the mean. (I.e. mean reversion theory) Overall I’d suggest that indeed the market has settled back into a sustainable upwards trend but that doesn’t mean there will not be significant corrections coming our way.
My view of the Australian stock market at the moment is that it now primed for significant correction and by significant I mean a fall of around 10% or more. I base this call on three main factors. First that the “Trump Rally” is overdone and there is no certainty Trump will be able to deliver on his most of his promises regarding the U.S. economy. Secondly I believe the RBA is probably going to be pressured into raising interest rates lest it wants to deal with a major house prices/real estate bubble. Lastly economic growth in China has clearly slowed since the heady days around the GFC despite many “experts” saying this would not happen. As the Chinese economy continues to cool there’s likely to be some shocks along the way and the property market in China might cause some market chaos this year.
Finally let’s look at what I consider is an important market indicator and one that doesn’t get a lot of attention – the ASX Small Ordinaries Index.
S&P/ASX Small Ordinaries Index (XSO) 5 Year Chart
The Small Ordinaries Index (XSO) is made up of ASX listed small cap companies and is a way to view the performance of the market with the big companies effectively filtered out. I find this Index useful because it’s more sensitive to the Australian domestic economy and less influenced by for example the price of oil or by global factors that would influence the price of stocks like Rio Tinto (LON:RIO), QBE Limited or Qantas. Looking at the chart above it’s pretty clear that the recent rally across the ASX 200 has not filtered down to the Small Ords. In fact the Small Ords Index has been moving sideways for some years and I think this more accurately reflects how the wider Australian economy is faring. Strip out home prices and resources and the Australian economy is not doing particularly well – although it has to be noted that the last recession was back in the early 1990’s.
As for my forecast for 2017 – well it would be relatively easy to make a bullish prediction for the Australian stock market this year since it’s currently still riding the Trump rally, interest rates are low and resources prices have recovered somewhat. However the underlying Australian economy appears weak and the recent rally seems overdone. Therefore I expect a signifiant correction will bring the ASX 200 down towards 5500 (or lower) during the year and that at best the Index will finish 2017 at around 5700.
Of course that’s just my forecast so I welcome readers to post their own views and for the record my forecast for last year can be found via this link: Australian Stock Market Outlook & Forecast for 2016.