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Over recent years giving investment advice has in theory been extremely difficult for those who have to do it. In practice it has of course been much more straightforward – just buy equity markets, simple as.
Equity markets have basically delivered very strong gains since the first quarter of 2009 and have effectively ignored most of the negative stuff that happened during a period of tumultuous economic, banking and political developments. The longer the cycle lasts, the more cautious one is inclined to be, but at the beginning of the past three years I have been somewhat cautious on equity markets, but on every occasion such caution has not been warranted.
2017 was no different. During 2017, the S&P 500 gained 20 % in local currency terms (5% in euro terms), the Dow Jones gained 25.6% in local currency terms (9.9% in euro terms), the FTSE 100 gained 7.6% in local currency terms (3.2% in euro terms), the German DAX gained 12.5%; the French CAC gained 9.3%, and the Japanese NIKKEI gained 19.1% in local currency terms and 8.2% in euro terms. All in all, these represent very solid returns, although the Brexit impact on the UK market performance was quite striking, but not in the least surprising.
It was an eventful year on the currency front, but the overall trend was one of euro strength against sterling and the dollar, but particularly the latter. During the year the dollar lost 12.4% against the euro and sterling declined by 4.3% against the European currency. These currency movements seriously undermined the returns gained by euro investors in the US and the UK and highlight the importance of currency exposure when making investment decisions. Currencies are always potentially volatile and are notoriously difficult to forecast, but their significance in terms of driving investment returns should always be an important consideration in any asset allocation decision.
I have always believed that economic fundamentals should be the most important driver of investment performance, followed by political developments and corporate performance. Of course, all of these factors are heavily inter-related, but the importance of economic growth is paramount and this was proven once again in 2017. In simple terms, 2017 was a good one for the global economy and business earnings. Furthermore, investors did not have too much choice in an environment of close to historically low bond yields and official interest rates.
Nine years into an equity bull run, one could be justified in being cautious once again, but many of the omens are still suggesting otherwise. 2018 should be a good year on the global economic front; bond yields should rise a little, but will still remain very low; and apart from the US, official interest rates are not likely to rise very much.
It is important to remember that the interest rate environment that we have lived with over the past decade has reflected extreme economic weakness and as that weakness dissipates, one would expect interest rates to return towards some semblance of normality. It is already happening in the US and to some extent in the UK, but the question is if and when it might happen in the Euro Zone? The reality is that the ECB still remains quite chilled about inflation and growth and while it will cease its bond buying programme under QE later in the year, it will more than likely be 2019 before official rates start to move back towards normality. However, if the current strong growth momentum is maintained, the ECB could start to become less relaxed as 2018 progresses. Euro Zone growth and inflationary tendencies will be watched very closely over the coming months by the ECB, but also by borrowers and investors.
One of the biggest risk factors for the global economy and consequently for markets in 2018 would be a larger than expected tightening of monetary policy. This would hurt still heavily indebted personal, corporate and sovereign borrowers. Central bankers will obviously be very aware and mindful of these risks and will be reluctant to change the policy stance too aggressively and too quickly.
Brexit will once again be the topic that will dominate sentiment and debate on this side of the world over the coming year. Eighteen months after the June 2016 referendum result, there is still huge uncertainty about how the process will evolve. However, given the nature of the politics involved on both the UK and EU sides, it is impossible to be certain of any outcome. This time last year I had sympathy with the Prime Minister’s position, but a year later it is much worse and appears to be weakening steadily as she lurches from crisis to crisis.
Other things to watch will be the Tweets of Trump and the mid-term elections in the US in November. Italian politics could also be interesting, with a general election due in March. As is normally the case with Italian politics, anything is possible.
At this juncture, none of these risk factors seems capable of knocking the global growth story off course and markets are certainly maintaining that stance. Just over a week into the new year, equity markets are still moving ahead quite strongly and investors appear to be in a positive frame of mind. It is shaping up to be a reasonable year for equity markets, but a note of caution is that the markets have been driving ahead since March 2009 and valuations now look a little challenging.