As investors look ahead to a new year, they could be forgiven for wondering whether they will be as pleasantly surprised in 2018 as they were in 2017.
A number of political worries on the horizon this time last year signally failed to materialise, including the likely shape of President Trump’s trade policies, the rise of populism in Europe and fears over North Korea. As it turned out, the market shrugged all these aside, with both interest rates and market volatility remaining close to historic lows, while stock markets hit new highs.
Nearly a year on, the same worries remain, compounded by the question of how markets will react to the gradual withdrawal of quantitative easing (QE).
Investors may well ask whether these problems have been deferred or whether markets will again take them in their stride.
We have gathered together the collective wisdom of our investment teams on these questions. A number of themes emerge:
- Valuations are stretched nearly everywhere, underpinned by low inflation and minimal interest rates. Japan stands out as one of the few attractively valued equity markets. In both Japan and Europe, stock prices should benefit from expanding profit margins which have room to catch up with other parts of the world.
- While both inflation and interest rates should rise in 2018, few foresee them getting out of hand. However, several of our investors suggest that the market consensus is too sanguine about inflation.
- One area of the equity market likely to stand out is value (cheaply-valued stocks). After the longest period of underperformance in over 40 years, the catalyst for a turnaround could be a rise in inflation and therefore interest rates.
- Assuming policymakers can successfully juggle sustaining the recovery with controlling inflation, global bonds should not experience much downside. A keen eye will need to be kept on inflation, though.
- In emerging markets, attractive yields for both dollar and local currency debt should be supported by continuing strong growth and relatively low inflation, alongside a stable dollar. Investors still need to beware of political developments though. In China, valuations look stretched, while growth may slow, dragged by debt reduction, particularly in the property market, and rising raw material costs, which may squeeze margins. However, domestic consumption and investment should hold firm, with selected sectors growing earnings.
- The overall background should be good for active managers, given a likely pick-up in both volatility and dispersion (the differences between individual stock returns), alongside a fall in correlations (the extent to which stocks move together).
- The challenges of managing businesses sustainably continue to grow, including the globalisation of policy, the increasing costs of misjudging technology and the ever-present background of climate change. Addressing them successfully will require an active approach.
If our forecasts prove accurate, GDP growth of 3.3% in 2018 will mark the strongest period for the global economy since 2011. More important will be whether policymakers can maintain the “Goldilocks” combination of strong growth and low inflation as QE is withdrawn in the US and Europe.
The main risk we see lies in reflation, as governments turn to lower taxes and higher infrastructure spending to stimulate economies, which could lead to overheating and unexpected rises in inflation and interest rates.
Overall, we carry a spirit of cautious optimism into 2018, albeit that caution may start to overwhelm optimism as the year wears on. It is certainly an approach we are adopting in our multi-asset portfolios, which go into 2018 with a pro-cyclical tilt in favour of equities, but with a readiness to ratchet down risk should circumstances demand it.
- The full series of Schroders' 2018 Outlook articles can be found here.
Important Information: The views and opinions contained herein are those of Peter Harrison, Chief Executive, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. The sectors and securities shown above are for illustrative purposes only and are not to be considered a recommendation to buy or sell. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. The opinions in this document include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change. Issued by Schroder Investment Management Limited, 31 Gresham Street, London EC2V 7QA. Registration No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.
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