Why the sharemarket’s immediate future is all about interpreting what’s happening now

Outlooks have suddenly improved for the year ahead and the markets are moving as investors digest how angst earlier this year turned out to be unfounded pessimism.

Bonds have been getting a lot of attention of late. Picture: Gaye Gerard

First things first. If you want to get a clear view on the outlook for next year you need to get a grasp on the action in the closing weeks of 2023.

The second thing is that you need to have faith. Not blind faith, but faith in the ability of sharemarkets to offer strong returns come hail or shine. Just like they did this year.

The headwinds of 2023 were substantial. Wars in Ukraine and the Middle East, strong inflation and elevated interest rates, and at home the costs of living and the “mortgage cliff” cast a cloud on consumer sentiment.

But for sharemarket investors the overall impact of those factors was ultimately insufficient to drag the market down.

To some extent that is because some factors – the mortgage cliff, for example – have not come to pass.

The other key factor over the year was the “surprising” resilience of China’s demand for Australian resources. That’s why Rio and Fortescue broke their all-time share price records in 2023 and the mining sector once again got the local market over the line into respectable returns for the year.

What really happened is that the market overshot in early 2023; unrestrained enthusiasm saw the ASX put on 8 per cent by mid February. I mentioned at the time that it might not be a bad idea to get out there and then, taking 8 per cent, with a plan to come back later.

Indeed it was only last week that we got back to that level of performance on a total returns basis.

For most of the year the local market was a poor cousin to Wall Street which has a price earnings ratio of closer to 22 and the S&P 500 on “price alone” is showing a year-to-date return of 23 per cent.

Nonetheless, it looks like the Australian market is going to romp home with a total return of more than 10 per cent.

The numbers are on the screen: The ASX 200 price index is up more than 6 per cent and the dividend yield for the market is about 4.3 per cent.

If you were an older Australian armoured with franked dividend stocks then the news is that your ASX sharemarket returns look like they will hit 12 per cent. Will that do?

You can subtract inflation and say it’s only half as good as it looks. Agreed. But you can do that for everything else too, from cash to property.

Most share investors these days have three paths into the market – individual shares, active share managers or index-based exchange-traded funds.

Whatever your mix, the main thing to know is the market is not expensive and the outlook from the companies themselves is encouraging. This healthy outlook is based on two key factors: The Australian market is sitting on a price-to-earning ratio of about 17 times and that is a teeny bit above average but not expensive. After the recent AGM season where there had been much negative anticipation, it turns out there were more upgrades than downgrades of company guidance.

But the single most important pointer for 2024 is that we have had a signal from the maestro of global finance Jerome Powell, the chairman of the US Federal Reserve, that we have come to the top of the rates cycle. In turn this means that inflation has been tamed and the only way for rates to go from here is down – perhaps in the second half of 2024.

US Federal Reserve board chairman Jerome Powell has hinted we’re at the top of the interest rates cycle. Picture: Getty Images

At a stroke the signal unleashes optimism in the market, especially for stocks that pivot on the need to be financed heavily for growth. In very general terms it is good for small stocks and technology stocks, it is very good for REITs and not so good for banks or insurers (who have just been recovering on the back of higher rates).

In our home market we cooling inflation, and softer rates should spur risk assets led by shares.

But there are two more key factors that will kick in during the first half of 2024.

Firstly, the economy is in much better shape than many realised. You only have to look at this week’s Mid Year Economic and Fiscal Outlook when an expected deficit of $13.9bn has shrunk to an updated figure of $1.1bn.

As always there was a bag of tricks involved in this statement and pushing out infrastructure costs was an important factor. But in the real world the key change was a powerful lift in mining prices. The single most important export product, iron ore, was assumed in the last budget to be $US66 per tonne and the spot price now is double that figure at $US128.

Secondly, the top end of the personal tax cuts program, which has been years in the making, will be introduced on July 1 and this is going to revive consumer spending.

As I mentioned recently, the cuts have been controversial and branded as a gift for the wealthy. Looking at the hard numbers, anyone in the salaried class who earns more than $200,000 a year will have a pay rise of more than $9000 and if this money is not spend on everyday expenses it will get invested.

Also a report by the independent Parliamentary Budget Office found that the average full-time worker will be $1500 worse off if the cuts don’t go ahead.

Putting better-than-expected commodity prices together with the personal tax cuts (with political risk now effectively removed following statements from Treasurer Jim Chalmers) the fundamentals are encouraging.

Opportunity knocks

If we look more closely at what happened on the ASX, the malaise in the market through mid year was linked with the end of the boom for coal and gas stocks. It was a torrid time for REITs (property trusts).

At the same time action in most of the banks was humdrum.

And then there were individual stocks that failed to fire. Among the top stocks year to date CSL (down around 4 per cent and Sonic Healthcare (up about 2 per cent) AMP, Magellan and Mirvac (all sitting virtually unchanged) would stand out as flops.

Looking across a range of broking reports and wealth advice notes at the end of the year, the standout opportunity “sector” is reported as REITs.

The property trust sector stands out because it has been dealing with the double whammy of rates that went higher for longer than anyone might have reasonably expected along with a reluctance among the world’s white collar workers to return to the office five days a week.

Similarly, the healthcare sector may find headwinds turning to tailwinds in the year ahead. Among the top stocks that did not come to the party in 2023 were Resmed – down a whopping 36 per cent for the year – and Ramsay Healthcare down 13 per cent.

As I mentioned earlier, individual stock picking is for those who want to build their own share portfolio with the inevitable mixed bag of winners and losers you get from this process; good investors simply have more winners.

If you want to get into the Australian sharemarket through an active fund manager then Morningstar has just released its large cap shares manager wrap – with the important dimension that the research group made its selection of the best operators “who have survived and indeed thrived over the very long term”.

Here’s the list, it’s too long and a 15-year record is great but “survivorship bias” is also very useful for some:

DIVERSIFIED FUND MANAGERS: Allan Gray, Fidelity, First Sentier, Lazard, Perpetual/Perpetual, Schroders and Tyndall;

BOUTIQUE MANAGERS: Ausbil, Alphinity, Greencape, Hyperion, Investors Mutual and Solaris;

Or you might just want to buy an exchange-traded fund based on the ASX. That way you won’t have to think or analyse anything much.

As for how will the ASX perform next year? I’ve been reporting on the market since the 1980s and in terms of forecasting I am more sure than ever that “nobody knows anything”.

We do know that the long-term average annual return of the ASX 200 (including dividends) is 9 per cent.

Originally published as Why the sharemarket’s immediate future is all about interpreting what’s happening now