Global markets have proven to be resilient despite the many macroeconomic uncertainties and political worries in 2017. Equity markets rallied to all-time highs while volatility remained subdued for most of the year.
There is no doubt 2017 was an exceptional year for many investors, but what will 2018 bring?
We have put together a list of key market themes investors should be considering this year, and included some fund recommendations for each theme.
Broadly muted returns
The equity bull market is now approaching its tenth year, and for US stocks this is the second-longest bull market since WWII (the longest was 1987-2000). This one differs from last time in that interest rates have fallen throughout. Bond yields have also declined to historically low levels.
The major concern now is that equity returns are being driven by investors bidding up prices in the global hunt for yield, while earnings have remained flat. Investor concerns are currently increased by whether markets are expensive or not, the impact of rising interest rates and where to allocate money around the globe.
While expectations are high that the US market will enter a period of relatively low returns, there are many bright spots to invest in such as Europe, Japan and Emerging Markets.
Investors should remember that in this challenging market environment, it is more important than ever to have a global well-diversified portfolio.
Europe: Marlborough European Multi-Cap Fund
Japan: Lindsell Train Japanese Equity Fund
Emerging Markets: Hermes Global Emerging Markets Fund
UK opportunities beyond Brexit
Uncertainty around Brexit and heightened political risk has led investors to shun UK equities, creating value opportunities. While Brexit negotiations will remain a headwind, the UK is still competitively priced relative to other equity markets.
And, if earnings improve after their poor performance in recent years, those valuations might become even more attractive for investors. Additionally, the fall in sterling post the Brexit referendum has boosted earnings for internationally-focused companies, providing support for dividends.
UK: Slater Growth Fund
Markets were complacent in the face of political and economic risks last year. Political instability in Europe and the US, concerns around North Korea and uncertain monetary policy among central banks have all been shrugged off by investors.
With volatility stuck at depressed levels, investors’ expectations are shifting to more sensitive environments given highly stretched market valuations. Therefore, it makes sense for investors to favour capital preservation, rather than return-seeking mode, by considering absolute return funds which typically aim to limit volatility and deliver positive returns in all market conditions.
Absolute return: Fulcrum Diversified Core Absolute Return Fund
Search for income – beware of ‘bond proxies’
Interest rates are expected to continue to rise in 2018, putting pressure on defensive dividend-paying equities to compete with fixed income assets. Over the past few years, the search for yield and safety in the low interest rate and volatile market environment, has led to increased demand for high-yielding defensive growth equities, with consumer goods and healthcare sectors perceived as a safe bet.
As a result, valuations in these sectors look stretched, which makes them vulnerable to interest rate rises, creating ‘bond proxy paradox’. In contrast, sectors such as financials, energy and materials have been out of favour since the financial crisis, but are expected to benefit from a recovery in commodity prices and higher interest rates.
Global income: Schroder Global Equity Income Fund
Higher Inflation and interest rates
As we move into an environment where the Bank of England, along with the US Federal Reserve, begin to accelerate monetary tightening in response to rising inflation expectations, investors are concerned that this could cause bond prices to fall and yields to rise.
So, now more than ever, investors need to look beyond traditional “safe” bonds and adopt a more flexible approach to address rising interest rates and inflation concerns.
Global bonds: M&G Global Macro Bond Fund
Sector to watch – Energy
Oversupply in the global oil market has kept pressure on crude prices, but many believe that the current situation is unsustainable, with a large proportion of production currently occurring at a loss.
Supply cuts by the OPEC oil cartel and slowly rising global demand could lead to more stable, higher prices over the longer term, creating a favourable environment for energy companies.
Energy: Guinness Global Energy Fund
Sector to watch – Financials
Since the Crash, financials have significantly underperformed the wider market. But the sector has undergone dramatic changes since then, with many financials having rebuilt their balance sheets, returned to profitability and paying dividends.
Regulations like Basel III (for banks) and Solvency II (for insurance companies) have forced banks and insurers to reduce their leverage, scale down risky assets and improve liquidity.
While the sector is still challenged in the low growth, low yield environment, the backdrop has shifted to one of reflation and rising interest rates, that should benefit the sector.
Financials: Jupiter International Financials Fund
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