Tis the season to be jolly, and with global share markets on the up it appears investors will have plenty of Christmas cheer. However, with the risk of a potential correction ahead, Australian investors are urged to avoid putting too much festive spirit into their stock picks.

As of 8 December, the benchmark S&P/ASX 200 index was at 5,994, showing a one-year return of 14 per cent, while the All Ordinaries index stood at 6,077, up by a similar margin. However, the Aussie market's gain compares to the 26 per cent one-year return of the US Dow Jones Industrial Average, or the technology-heavy Nasdaq Composite Index's 27 per cent rise.

Winners and losers

"The winners [in Australia] this year have clearly been anything to do with iron ore and resources, mining services, and to some extent oil as well. Several companies have gone up by two or three times, and if you had a lithium tailwind that didn't hurt either," said Morningstar's head of equities research, Peter Warnes.

"China has continued to suck in imports, which has obviously been helped by their closing down of expensive and poor-quality coal and iron ore operations from a pollution viewpoint, and that has helped those sectors.

"Elsewhere, the building material companies have continued to do well, albeit the east coast residential boom has peaked. Companies like Adelaide Brighton (ASX: ABC) and Boral (ASX: BLD) to a lesser extent are benefiting from government infrastructure spending."

However, on the downside, Warnes said the telecommunications sector had been "the biggest loser … they've been belted … and the big four banks have come under a lot of pressure from regulators and government too".

The insurance sector had also disappointed investors, with weaker earnings from major insurers such as QBE Insurance Group (ASX: QBE) and Suncorp Group (ASX: SUN).

Looking ahead to 2018, Warnes said the stock market could end lower next December than at the end of March 2018, with a "meaningful correction" likely for 2019.

"There's a very high level of expectation in the markets at the moment, particularly the US market on tax reform, and the delivery of it. If those expectations aren't met, we could see a correction much earlier," he said.

Because of this risk, Warnes urges investors to hold "a good slice of cash, because that gives you the optionality when the market does fall back".

Stocking fillers

Despite the caution, Warnes suggested a number of stocks for investors to consider as stocking fillers, including energy stocks Santos (ASX: STO) and Woodside Petroleum (ASX: WPL).

"The key drivers there are rising Asian wealth and their gas developments. The oil price is holding up much better than expected, boosted by OPEC cuts, and Santos and Woodside will do well at current prices," Warnes said.

In infrastructure, Warnes pointed to Auckland International Airport (ASX: AIA) as being favoured over its Sydney rival, "just because it hasn't got the aggressive financial leverage and has a wider economic moat".

Morningstar's Adam Fleck suggests Auckland is unlikely to face any competition in the foreseeable future, protecting its position as New Zealand's predominant airport, while its retail business also offers a "high-margin growth opportunity".

Among retail stocks, Warnes suggested pet care company Greencross (ASX: GXL) "because of the humanisation of the pet space," although he said household spending would remain under pressure due to sluggish wages growth, rising expenses and low savings.

He also pointed to Domino's Pizza Enterprises (ASX: DMP) and Premier Investments (ASX: PMV), although the arrival of US online giant Amazon could further weaken department stores and other retailers.

For technology-minded investors, Warnes nominated online retailer Carsales.com (ASX: CAR), accounting services company MYOB Group (ASX: MYO) and software company TechnologyOne (ASX: TNE).

In healthcare, he tipped private hospital operators Healthscope (ASX: HSO) and Ramsay Health Care (ASX: RHC) and medical services company Sonic Healthcare (ASX: SHL).

Meanwhile, while the US Federal Reserve is widely tipped to raise interest rates this month and again in 2018, Warnes said Australia's central bank would remain on hold through to 2019.

"I don't see how they could make a case for increasing interest rates here for a year or more … I don't think wages growth is going to explode and they know the household sector is too big to fail. The savings ratio is at a nine-year low--the household can't afford an interest rate rise," he said.

Will Santa bring more cheer in the form of an interest rate or tax cut? Warnes said the best investors could hope for was for the federal government to find $40 billion under the Christmas tree to deliver a "meaningful cut" to income tax, instead of corporate or other tax measures.

In the meantime, sticking to Morningstar economic-moat-rated stocks appears the best suggestion this festive season, if Australian investors wish to stay as jolly as Santa.

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Anthony Fensom is a Morningstar contributor and owns shares in Ramsay Health Care. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria. The author does not have an interest in the securities disclosed in this report.

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