NFU Mutual’s chief investment manager Paul Glover on the outlook for investment markets
Over the longer term asset markets are predominantly driven by a combination of economic and corporate prospects and valuations, but occasionally politics can certainly create periods of shorter term volatility.
With the world still suffering from subdued economic growth since the financial crisis and rising inequality leaving many people feeling worse off, there is a growing backlash against globalisation and the free movement of goods and people. The desire for populist solutions and change has already been seen in the Brexit vote and there are many elections looming which could have market implications. The next important electoral test is in the US and markets are wary of a possible Trump victory, but Europe also sees political risks from forthcoming elections in a number of key countries and an Italian referendum.
Post EU Referendum impact
Brexit was a surprise to the markets, but after the initial volatility the impact to date has been broadly positive for investment returns. We have seen a large fall in sterling, a new Prime Minister, Bank of England intervention, a rise in inflation and an economic slowdown that has been less than feared so far. However, it should be remembered that the actual Brexit process has not started yet and negotiations to find a mutually acceptable balance between single market access and border controls and financial contributions will not be easy so investors should remain vigilant to the risks.
Central banks have played a vital part in helping economies and markets navigate the post financial crisis period, but monetary policy appears to be reaching the limits of its effectiveness. Markets will be focused on whether the US Federal Reserve will raise interest rates again, but even though most other countries are not looking to raise rates for the foreseeable future the boost from ever lower rates supporting asset returns and higher valuations may be about to fade. Going forward we may begin to see fiscal policy and infrastructure spending replacing rate cuts and quantitative easing as the vehicles to provide economic stimulus.
UK economic growth forecasts have been reduced mainly due to the impacts of Brexit related uncertainty on business investment and rising inflation on consumer spending and the outlook is unclear, but the more important global economic outlook remains reasonable overall.
Corporate profit growth in the UK has been disappointing in recent years, but the weaker currency and recovering commodity prices are expected to provide a much needed boost. With many equity markets nearing new highs we have seen valuations become a little elevated on some measures, but a UK dividend yield of over 3.5% still offers attractions relative to the income available from cash and bonds.
Within international equities, the improvement in sentiment towards emerging markets has continued as concerns over China have eased and this has proved beneficial to the performance of many of our investment portfolios. Currency moves will continue to play an important part in the overall return to UK investors from owning overseas companies and Brexit discussions will certainly influence the direction of sterling over coming months.
Many factors have driven bond yields down to exceptionally low levels which have delivered good long term returns from government and corporate bonds, however the risks are rising and there is little income to support returns if yields begin to rise.
UK interest rates
With relatively subdued economic growth and heavy debt levels still in many areas, we are likely to remain in a low interest rate environment by historic standards for many years and we may even see a further UK rate cut if the economy needs support. However, with government bond yields at very stretched valuations and with inflation starting to rise and the potential shift from monetary towards fiscal policy, we believe the prospects for longer term real returns are poor.
With yields so low in the fixed interest world, our relative preference remains for investment grade corporate bonds given their additional income support and very modest default risk.
The commercial property market appears to be settling down again somewhat after the Brexit related volatility and liquidity issues. Overseas buyers could be attracted by their increased buying power following the decline in sterling and the shorter term price falls could create opportunities for longer term investors in good quality, long leased and well let assets where rental yields would look attractive relative to other asset classes such as bonds and cash.
Long term view
With UK interest rates potentially falling even lower and with them looking set to remain extremely low for an extended period, the returns available from cash deposits will struggle to match inflation. Markets may see volatility as we navigate the post-Brexit environment and a number of political risks, but on a medium to long term view equities and property still offer the best prospects for returns ahead of cash, although strong returns from current market levels are unlikely. 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.