Chief investment manager Paul Glover looks ahead
The unexpected events of 2016 and the equally unexpected market reactions to those results were a useful reminder of the folly of trying to focus too much on forecasting short term events. Investment should be viewed with a medium to long term mindset and over this timescale the impact of events causing short term volatility will be outweighed by the importance of the more fundamental drivers of asset returns, namely economic and corporate prospects and valuations.
Whilst the global recovery from the impact of the financial crisis has been slow and patchy and there are still pockets of difficulty, there are increasing signs that economic growth and inflation are moving towards more normal levels and the need for exceptionally stimulative monetary policy appears to be reaching a turning point.
UK growth in 2017
UK economic growth remained relatively robust throughout 2016, but despite the lack to date of a significant negative Brexit reaction, most economists continue to expect the combined impact of uncertainty on business investment and rising inflation on consumer spending to reduce GDP growth to around 1-2% in 2017.
There could be a danger of complacency over the potential impact of Brexit given we have still not yet started the formal exit process and many difficult decisions and negotiations lie ahead, but hopefully we will get more clarity on some of the key issues once Article 50 is triggered and decent solutions can be found that will support the longer term attractions of the UK economy.
All of our mixed asset funds have exposure to international equities and UK equities also derive a substantial proportion of their sales and profits from outside the UK, so the health of the global economy is ultimately more important than that of the UK to investment prospects. Here the position is looking relatively optimistic, with the key US economy looking healthy even before the potential additional stimulus from Mr Trump’s pro-growth policies.
Europe and Japan are showing signs of improvement after a difficult few years and emerging market economies overall are seeing good levels of growth after a period of local issues in some areas.
The strong run in equity markets in recent years during a period when corporate profit growth has been in the doldrums has left valuations looking a little elevated on some measures, but it looks hopeful that the recent signs of improvement in profit and dividend growth will be sustained. Despite some domestic concerns, UK corporate profits and dividends are well placed to benefit from recovering commodity prices and the decline in sterling and a dividend yield of over 3.5% still offers attractions relative to the income available from cash and bonds.
International market developments will focus somewhat on what Mr Trump can deliver and also the outcome of key elections in Europe, but the underlying momentum of fundamental market drivers looks relatively positive as we enter 2017. With many equity markets nearing new highs overall valuations are by no means cheap, but across the globe there still remain some relatively attractive investment opportunities, especially in some of the more out of favour areas.
Emerging markets were a key driver of good performance across many of our investment portfolios in 2016, although their momentum was slowed somewhat following Mr Trump’s victory on concerns over his free trade policies and the impact of dollar strength and rising US interest rates. Market sentiment may continue to swing around in this area, but the underlying outlook overall still looks relatively positive and valuation attractions remain.
Many factors drove bond yields down to the exceptionally low levels seen in 2016 and this has delivered good returns from government and corporate bonds over a long period. However, there are growing signs that these bond friendly conditions are beginning to turn and there is little income to support returns if yields begin to rise, so investors should be mindful of the potential difficulties in this traditionally lower risk investment area.
With heavy debt levels still facing households and challenges caused by ageing demographics we are likely to remain in a relatively low interest rate environment by historic standards for many years and may have entered a new lower rate era. However, with bond yields at stretched valuations, inflation starting to rise, potential monetary policy normalisation and increased use of fiscal policy we believe the prospects for longer term real returns from bonds are poor and a period of very low or even negative returns is quite possible.
With very modest default risk currently and additional income support compared to government bonds, our relative preference in the fixed interest world remains for investment grade corporate bonds.
Shorter term prospects for the commercial property market remain somewhat unclear as pricing remains uncertain and transactional volumes are low as it responds to the post-Brexit environment. With good rental income yield support relative to other asset classes and still good demand from overseas buyers a period of low to mid single digit returns looks likely and may lead to some interesting purchase opportunities.
Despite the anticipated gradual normalisation of monetary policy, UK interest rates are set to remain extremely low throughout 2017 and with inflation likely to move above 2% this year cash deposits will struggle to offer real returns.
In summary, on a medium to long term view equities and property still offer the best prospects for returns ahead of cash and inflation and our portfolios remain tilted towards those assets where possible. However, strong returns from current market levels are unlikely and markets may see short term volatility as they assess the likely impact of Brexit and Trump and navigate the other looming political risks. We have increased the exposure to cash across our mixed asset portfolios to take advantage of any opportunities that may arise in the markets. Whilst fixed interest assets may struggle to deliver decent longer term gains they can still offer diversification benefits in this uncertain environment.
As always, investors must be prepared for some periods of volatility by ensuring their overall investment portfolio is well diversified.