There had been concerns that 2017 conditions were as good as it gets for investors, with good economic growth, strong corporate profits, subdued inflation and supportive central bank policies. Although changes to these conditions are only likely to be gradual, we need to be mindful that after such a long period of economic expansion we could be approaching the latter stages of the cycle and be alert for signs of a slowdown or potential recession.
However, for the first time since the financial crisis all significant economies are growing and this healthy global synchronised growth environment looks set to continue at least through 2018, although there are signs that some economies may have already peaked.
The US economy was already in good shape even before the boost to growth expected from the passage of tax reforms. However, there are concerns that with President Trump’s protectionist rhetoric now having moved to concrete tariff proposals largely against China, growth is being put at risk. Whilst it is widely acknowledged that trade wars are bad for the global economy and negotiations may ultimately limit the actual impact, given the importance of the economies involved and the strong characters there is a possible danger of escalation beyond what markets have already priced in.
Elsewhere, confidence has grown in the European economic recovery to a level where the European Central Bank are now looking to reduce their crisis era monetary stimulus programme. The Italian election showed that the rise of political populism is not over, but to date the strong showing by anti-establishment parties has not unsettled investors. Emerging markets also remain prone to political ups and downs, but economically they continue overall to be the main drivers of global growth.
Although UK economic growth forecasts remain relatively modest, we have seen some more positive news around Brexit negotiations and inflation has now dropped below wage growth once more and should provide some support to consumer spending. Further signs of a softer form of Brexit would help reassure investors, although the challenging political situation and prospect of a potential hard left UK government is another issue that may become more of a focus as the year progresses.
Having largely ignored them last year, the potential risks from political and geopolitical issues are more on the minds of investors this year. President Trump has added a new degree of uncertainty to US policy making, but generally speaking these issues are rarely significant enough to have a meaningful impact on the fundamental economic and corporate outlook.
The other key risk area to watch is the activity of central banks as they look to withdraw the exceptional level of monetary policy support that has aided the post-financial crisis economic recovery and boosted asset prices. With increased confidence in the global recovery and some signs of inflation making a modest comeback in countries such as the US, central banks are expected to raise interest rates and reduce or reverse quantitative easing. Central banks are expected to progress slowly with policy changes to avoid destabilising asset markets, but any signs that inflation is getting out of control will raise concerns that monetary policy normalisation will need to accelerate.
Bond markets have enjoyed a very long period of gains as yields have moved ever lower, leaving valuations stretched. Structural factors such as demographics, high debt levels and the impact of technology on inflation have helped justify interest rates and bond yields remaining relatively low by historic standards, but the gradual normalisation of monetary policy is likely to put some pressure on fixed income returns. With very little income support for government bonds returns could easily be eroded by capital losses, although they remain an asset class that normally provides some protection for a portfolio in times of market stress. The additional income from corporate bonds provides some additional support relative to gilts, but with the yield spread at relatively low levels they would be more vulnerable were the economic cycle to deteriorate.
Strong equity gains in recent years have left most valuation measures at above average levels, although we are currently seeing good corporate earnings growth which alongside a healthy dividend yield (especially in the UK) should support equity markets. Although there are short term UK specific challenges to overcome such as Brexit and political concerns, with UK equities now the most out of favour asset class amongst global investors there is already a lot of bad news priced in. With relative valuation attractions emerging on a longer term view, we are looking for opportunities to purchase quality UK companies at attractive prices.
Whilst emerging markets remain the most volatile of the equity categories they still retain their longer term valuation attractions despite a good run of outperformance. Superior economic growth, improving corporate earnings and their evolution away from commodity related earnings towards higher quality growth areas such as technology has encouraged investors to increase their exposure.
The UK commercial property market is experiencing solid levels of transactional activity as investors from both the UK and overseas continue to see the benefits of property as a long term asset class. Returns are however forecast to be low single digits for the next few years as capital growth prospects look limited. Rental income will underpin short term returns with some sectors of the market currently offering scope for rental growth.
The gradual normalisation of monetary policy around the world is currently expected to include a small number of gentle UK interest rate increases in coming years, but rates will remain very low by historic standards and higher inflation has left cash deposits struggling to offer anywhere near real returns for savers.
In summary, the current healthy global economic and corporate situation looks set to carry on at least through 2018, although conditions may be peaking. The return to more normal levels of market volatility look set to continue and after an extended period of healthy market returns which has left most asset classes relatively highly valued we should now expect a period of more modest returns.
With bond valuations looking unattractive, equities and commercial property still offer the best medium to long term prospects for returns ahead of cash and inflation and our portfolios remain tilted towards those assets where possible.
As always, investors must be prepared for some periods of volatility by ensuring their overall investment portfolio is well diversified.
Please remember that past performance is not a reliable indicator of future results. The value of investments and the level of income received from them can fall as well as rise, and is not guaranteed.
You may not get back the amount of your original investment.