Where are stocks heading in 2018?

ASX

The Australian stock market has staged a solid rally through the course of 2017, delivering some long overdue positive returns for investors.

The ASX200 started 2017 around 5,660 points. It is currently trading around 6,025 points, a rise of around 6.5 per cent. When the 4 to 5 per cent average dividend yield is added to this performance, the total return for the year is well above 10 per cent.

This is a great result in an era when wages and inflation are both stuck at 2 per cent or less and when term deposit yields are around 2.5 per cent. Indeed, in that context, a 10 per cent return is very impressive.

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Heading into 2018, the outlook for the stock market remains positive with many of the positive influences of the last year still well in play.

The rate of bottom line real economic growth is set to remain around 2.5 per cent. While this is certainly not strong, it is enough to see efficient and agile firms build earnings and profits. Strong exports, further growth in public sector infrastructure and a welcome increase in private sector business investment will underpin the economy, albeit with an offset likely from on going sluggishness in consumer demand.

Recent business surveys of profits expectations, from NAB and illion, show a buoyant profit outlook which is being assisted by low and declining interest costs and well-contained increases in labour costs as wages growth hover near record lows. Indeed, both surveys are currently showing businesses to be more positive about the profit outlook than they were at the start of 2017.

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Stocks could also be in line for a boost from investor demand. With interest rates set to remain at historical lows and perhaps fall further, investment allocations should see a skewing towards stocks. While there is some risk to capital values from stocks, a 4 to 5 per cent dividend yields is roughly double the yield on a term deposit. Only when interest rates rise and rise markedly is there likely to be an asset allocation decision away from stocks and towards deposits and bonds.

At the same time, the slide in the property market and house prices in particular is likely to see investors reassess their strategies for the best investment returns. To the extent there is a reallocation of investment funds away from what has been a strong property sector and towards shares, the ASX is likely to get a further boost.

Indeed, if there is outright selling of houses and the funds are allocated to stocks, the effect could be substantial.

Forecasts for the ASX are always hazardous when there are so many unforecastable variables that can have a significant impact on markets. Geopolitical issues, Trump, central bank interest rate policy and a myriad of other events can unexpectedly impact markets.

But based on what is unfolding in the economy and in the corporate sector, a further 5 per cent rise, plus dividends could easily be achieved. This puts the ASX200 at 6,350 points by this time next year. Not a bad return where interest rates, inflation and wages are all set to be around 1.5 to 2.5 per cent in 2018.