What to expect in 2018

The start of a new year always brings with it a sense of hope and new direction, but what sort of trends might we see in the investment world?

Global markets started the year strongly. A slight dip on 2 January from the last day of trading on 29 December saw the FTSE 100 breathe slightly before rising steadily to an all-time high of 7792.56.

The S&P 500 has been nudging 2,802.56 over January, President Donald Trump has been tweeting about the record highs on the Dow Jones, the Nikkei 225 has been edging above 23,700 and even up to 24,000, and the strong performance seen on the Dax in the second half of 2017 seems to be continuing into 2018. So far, so good.

Over 2017 market dividends have also been strong, despite commentators talking of ‘compression’ on equity income yields. With 4.2 per cent currently on the FTSE 100, above 3 per cent inflation, investors are still seemingly being compensated in both growth and yield.

And despite inflation creeping up, and fixed income yields remaining tight - especially in developed economies - there are still advocates of higher-yield and selected corporate bonds.

But can the good times continue to roll?

Presaging the downturn

Donald Maxwell-Scott, technical investment manager at Rowan Dartington, questions whether another financial crash is looming.

“The saying goes that the bull goes up the stairs and the bear falls out of the window. Global markets have continued to rise steadily; it seems there is nothing on the horizon to temper them, or is there?”

Although the markets have been on an impressive run, Mr Maxwell-Scott says there is “no shortage of market commentators predicting we are moments away from the end and financial doom awaits us all”.

But while they are warning about the crash, they are not predicting reasons why it might happen – and without any consensus on what might cause it, together with overweening government interference, quantitative easing (QE) and rising household debt, he feels there may not be one be-all, visible contributory factor to a crash.

For this reason, it is very hard to forecast when and whether and how deep a potential crash might be.

Gloomily, he presages: “We wouldn’t be so foolish as to predict when the next financial calamity will strike or what will be the cause, but with the amount of stimulus and action by governments it is unlikely to be one factor, but rather several different ones.”

Green for go in the UK?

Forecasts for the UK do not look great, if figures from the Organisation of Economic Co-operation and Development, as well as the UK's Office for Budget Responsibility, are anything to go by.

For example, the UK is forecast to see one of the lowest rates of growth in the G20 over the next 12 months in GDP (1.6 per cent) and corporate earnings (6.5 per cent), as a result of a tapped-out consumer and diminishing investment flows.

With uncertainty around Brexit and fears over continued capital flows into the UK, some fund managers and wealth managers are feeling less positive about the ability of UK equities and bonds to power through these political problems and emerge successful.

Chris Godding, chief investment officer of wealth management group Tilney, comments: “We have been reducing exposure to UK assets as we are wary of markets that become highly sensitive to political developments.”

There might be a correction or two, but for Russ Mould, investment director at AJ Bell, the five key danger signals are just not “flashing danger” when it comes to UK equities in 2018.

This quintuplet of possible danger comprises:
1) Transportation
2) Copper prices
3) Small-cap companies
4) Volatility
5) Valuations and the dividend yield.

But instead of copper prices trending down, small caps losing momentum, transportation stocks stalling, volatility peaking and valuations looking way too stretched - all of which would scream 'beware' - he finds the opposite is happening.

Take volatility. According to Mr Mould: “History shows stock indices progress best when they make serene progress and a series of modest gains, and tend to fare less well when trading is choppy and there are big swings up and down.

“The FTSE 100 moved higher with a minimum of fuss in 2017 when there were just 17 open-to-close movements of more than 1 per cent in the index throughout the whole year.

“That was the lowest total since 2005’s reading of 18 and the UK stockmarket advanced smartly for a further 18 months after that.

“Further peaceful gains, in incremental steps, would further encourage this is a bull run and not some frenzied bubble that is primed to burst, assuming historic trends repeat themselves.”

In summary, he says these five signals are together still “flashing green for go”, even though we have had a nine-year bull run in UK stocks and what goes up surely must come down.

It just might not come down sharply in the near future, seems to be the message from these five indicators.

But what about the rest of the world? What of monetary policy, global fixed income, China and, of course, the US?

Monetary normality

Sterling started to show more strength at the beginning of 2018 as fears of a US government shutdown started to gain momentum.

This wasn’t a resounding show of support for the pound itself, but a sign of dollar weakness.

Miles Eakers, chief market analyst at Centtrip, comments on how sterling climbed to its highest level against the dollar, at 1.3932, in 18 months during January.

He says: “The fall [in the dollar] comes amid the looming possibility of a government shutdown as Republicans struggle to secure a stop-gap bill and Democrat leaders are blocking legislation to fund the government further until President Trump concedes ground on his immigration policy.

“While political turmoil has been taking its toll on USD, perhaps Trump’s tax plan may offer some hope of a recovery for the US currency?”

Eugene Philalithis, portfolio manager of the Fidelity Multi Asset Income fund, is pretty sanguine about the prospects for the dollar.

He explains: “While we do not expect a material appreciation in the dollar across 2018, we still expect it to strengthen across the year.

“The currency has been testing its lows from the past two years, but the strong economic backdrop should mean it avoids any further depreciation, especially after 2017’s meaningful correction.

“At the same time, currencies like the euro remain vulnerable to political risks, with Italian elections due to be held before May this year and ongoing uncertainty around Brexit and the make-up of a governing coalition in Germany.”

Mr Godding believes while currency moves are difficult to call, Tilney’s “base case at the moment is that sterling will remain cheap or weaken relative to the dollar and euro”.

Over the longer-term, some commentators believe the biggest currency surprises might be from Europe, rather than the US and the UK.

Enzo Puntillo, head of fixed income for GAM, states monetary policy at the European Central Bank (ECB) might be something for investors to watch this year.

He says: “From a relative perspective, we believe the ECB is more likely to surprise the market than the Fed.”

Europe

When it comes to fixed income, fiscal policy might have a role to play in how managers structure their bond portfolios in 2018.

For example, as a result of the ECB’s monetary policy, Mr Puntillo suggests there could be better performance seen in the US than in Europe.

He explains: “Given the fact that the European cyclical economic expansion is less mature than in the US, this would support a convergence of the spread between German and US 10-year bond yields, meaning German Bunds are likely to underperform against US Treasuries.

“This is a key theme we will be playing in our portfolios in 2018.”

Mr Maxwell-Scott adds: “QE has run into the trillions globally, and now the health of the global economy is seemingly improving, many central banks are reining in their programmes.

“The worry is that this feature, when coupled with increasing interest rates, could lead to a significant fall in bond markets.”

But Niall Gallagher, investment director for European equities at GAM, is more upbeat about Europe’s prospects.

He comments: “We have two key investment themes underpinning our stock selection process.

“On the one hand, we have exposure to long-term secular growth trends: emerging market consumption growth, transfer from the physical to the online world, and disruption of whole industries through new technology.

“On the other hand, our medium-term focus – the one with more potential to drive returns in 2018 – is our positive and above-consensus stance on European domestic demand.

“We are positioned to benefit from a eurozone demand recovery through select key holdings in building and construction materials, consumer spending and business investment.

“We believe the risk/reward profile is highly skewed to the upside, with a multi-year recovery potential.”

US outlook

If you follow President Trump on Twitter, barely a day goes by without positive-sounding tweets about the strength of the US equity market and the positive upswing across various sectors.

As of Wednesday 17 January, the Dow had closed with a gain of 31.7 per cent since President Trump’s inauguration date of 20 January 2017.

All eyes were on the industrials to see how it would fare by close on Friday 19 January, as the index was on course to have generated the best return ever in the first year of any post-war president.

“This is something which Donald Trump may well be keen to crow about on Twitter,” according to Mr Mould.

The following table shows the rise in stockmarkets in the first year of US presidential terms since 1949.

President Obama's first year in his first term has been the strongest so far at 33.4 per cent, but Mr Trump has been hot on his heels.

The S&P 500 has also gone from strength to strength.

The Faang stocks – Facebook, Apple, Amazon, Netflix and Google – have driven the large-cap markets ever-higher but how much bigger can these behemoths get?

Can they push price-earnings ratios even higher in 2018? And what sort of risks might a heavy skew towards social media companies pose for the index?

Tilney’s Mr Godding comments: “The strength of the global economy is a double edged sword for investors.

“Higher growth leads to higher corporate earnings and the rise in equities last year was principally driven by strong earnings growth.

“However, GDP growth can also lead to the real economy absorbing more of the excess liquidity in the system, via higher investment and working capital to effectively crowd out financial money flows.”

With lower tax rates to be implemented in the US this year, following a last-minute successful passage of a tax bill through congress and the senate in December 2017, Mr Godding says the tax rates should incentivise investment in capital assets.

He adds: “US equity returns this year should broadly reflect the circa 12 per cent earnings growth currently factored in by the markets.”

Japan

While Japanese 10-year government bonds are still sitting at 0 per cent, there doesn’t seem to be a thriving fixed income market, but for equity investors the prospects for 2018 might be a little more rosy.

According to Ernst Glanzmann, portfolio manager for Japanese equities at GAM, there are significant strides being made in automation and robotics, which is helping to fuel better efficiency in terms of labour and employment.

He says: “One of the top themes for Japan in 2018 will be more work process improvement due to an ever tighter labour market.

“Companies will be eager to contain cost pressure as much as possible. One way of doing this is by further standardising processes through the application of IT-based solutions –automation, robotics, artificial intelligence and the internet of things.”

China

Few investors will forget the beginning of 2016 when Chinese growth slowed down so much global indices trembled.

But over 2017, Chinese GDP surprised on the upside, with 6.8 per cent annual growth, a recovery in industrial production and fixed asset investment, with stronger exports, up 8.8 per cent on 2017.

According to some commentators, Chinese consumers are going to be a strong trend, as the country undergoes its economic evolution to a consumer-driven economy.

Luxury companies in the consumer, technology, healthcare and financial services sectors are continuing to experience strong growth, although overall retail sales growth was slightly lower at 10.2 per cent compared with 10.4 per cent in 2016.

But has China’s growth story peaked? Craig Botham, emerging markets economist for Schroders, believes there is resilience and strength in the country for investors in 2018.

Mr Botham explains: “The data paints a picture of an economy supported by a strong external backdrop.

“Our own forecasts suggest continued strong growth for the rest of the world in 2018, so the export sector should continue to provide support for the economy, even if an acceleration is unlikely.”

Other themes for 2018

There are other themes to watch out for this year, as certain demographic groups emerge and disruptive technologies drive change.

GAM’s Scilla Huang Sun, portfolio manager for luxury equities, says the team’s “big theme” for 2018 is: “What do millennials really want?

“Millennials are increasingly becoming the main target group for most luxury companies.”

Then there is the rising green economy. Lisa Beauvilain, head of sustainability and ESG at Impax, says: “Carbon risk in investment portfolios is becoming widely acknowledged.

“We believe we will continue to see increasing focus and effort from asset owners on improving investee companies’ carbon risk management and disclosures following the Task Force for Financial Disclosure (TCFD) recommendations that were launched in 2017.”

She believes investors are also likely to be highly focused this year on the risks and opportunities stemming from issues such as single-use plastics and packaging, as well as cybersecurity.

Ms Beauvilain adds: “Mapping the sustainable development goals (SDGs) to investments and companies looks set to continue in 2018, but we believe these need to be assessed and reported with improved intentionality and rigour.”

Conclusion

There are reasons for concern as equity markets stretch higher, fiscal intervention by governments starts to loosen and bond yields remain contracted.

Wariness, rather than unabated enthusiasm (such as we have seen in the recent crypto-currency frenzy) should be the watchword this year.

But even in sectors where there has already been years of strong growth, fund managers believe there will be opportunities for canny investors.

Moreover, new growth markets are starting to emerge in clean energy, technology and luxury retailing, suggesting there are some interesting pockets of promise for investors to consider over the course of 2018.

Simoney Kyriakou is content plus editor for FTAdviser