2017 was a good year for overseas equities, particularly the US and Japan, while 2018 has kicked off with very low levels of equity volatility. Against this backdrop, Brad Holland, our senior investment manager, considers what this year may hold for financial markets.
Overseas equity markets performed well in 2017, with the UK lagging due to Brexit concerns. For the year ending 31st December, total returns were 22% in the US, 21% in Japan and 12% in the UK. 2018 opens with equity volatility at very low levels compared to both the long-term norms and the levels seen in the second half of 2016.
Given that 2017 delivered on equity returns and volatility is so low, is it time to think about when the equity bull market will run out of steam?
Equity performance expected to continue
Here at Nutmeg, we think about when equity bull markets will run out of steam all the time…very carefully. And we believe the equity rally has further to run this year.
While the economic cycle is getting ‘long-in-the-tooth’ in the US and other major economies and central banks are, although slowly, withdrawing the monetary stimulus so important to the financial healing process of the past decade, there are several reasons to expect further upside in equities.
Firstly, household incomes and corporate profits are still rising. That’s a positive income story that underpins consumption and investment spending for a time.
Secondly, fiscal policy is generally supportive of growth in all the major developed economies. While the US tax cuts are a temporary confidence booster, they come at a time when there are other pro-growth trends supporting investment spending. One of these is the long period ahead of infrastructure investment; another is the ‘re-shoring’ of US imports — a trend that was well established before Trump’s ‘Make America Great Again’ campaign got underway.
A third reason we expect equities to perform well in 2018 is that emerging market economies are now also growing in line with developed ones. This ‘pulling together’ of global demand helps underpin global trade and risk appetite.
However, there is one major disclaimer to this ‘rosy’ emerging markets picture: the behemoth Chinese economy is now in a structural slowdown phase for at least the next five years. Its ‘grow at all costs’ economic model has had some damaging side effects and the authorities are now learning they must accept growth rates half those of the pre-crisis period. But a sustainable Chinese economy — although at a lower growth level — is not bad news for the global risk picture.
But there’s two sides to every story…
One doesn’t have to look too hard to find potential bad news for equities.
Bond yields are rising, and if that rise becomes too steep some of the corporate investments being planned could be shelved. Central bank policy is critical here, but we expect them to raise official rates slowly so as not to derail the acceleration in global growth.
Furthermore, we expect inflation to rise during 2018, but not to the extent that central banks will need to tighten policy too aggressively.
Other potential problems for risky assets could stem from:
- geopolitics — Middle East, North Korea, China-Sea disputes (East and South China Seas)
- markets — oil prices, Bitcoin, bank restructuring
- politics — Brexit, Italian election, US mid-terms.
The outlook for Nutmeg portfolios
Nutmeg’s fully managed portfolios should continue to benefit from our evolving assessment of all these factors.
For the time being, our fully managed portfolios remain tilted towards equities, away from bonds and reflect our bias towards US, Japanese and emerging market equities.
We anticipate a stronger UK currency as Brexit negotiations improve the prospects of a favourable outcome. Too much Brexit-pessimism is still factored into UK currency and bond valuations.
Risk warning: As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past or future performance indicators are not a reliable indicator of future performance.
Sources: Bloomberg and Macrobond
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Brad Holland
Brad is Nutmeg’s director of investment strategy. A veteran – 28 years at last count – in financial markets, he started his career as a professional economist at the Australian Reserve Bank. He now specialises in economic and financial market strategy within investment management. Brad studied post-graduate quantitative economics at the University of Queensland, Australia. Despite living in London for 20 years now as a naturalised British citizen, he’s still not quite ready to support England-v-Wallabies.Other posts by Brad Holland