Every New Year brings the opportunity to address those things we feel we can do a little better. That equally applies to our investment portfolio and is dependent upon assessing the opportunities for the year ahead.
Here we take a look at the prospects for:
Our analysis starts with stock markets as this is most relevant to most investors. In 2017 the FTSE All-Share index delivered a total return (including dividends) of 12.3%, which was in line with global markets with the MSCI World index gaining 12.7% in sterling terms.
The big question for 2018 with stock markets hitting new highs around the world is whether there is still momentum in this bull run or is now the time to sell?
Below we take a look at the wide range of opinions out there.
Equity markets in 2017 experienced much lower volatility after the roller-coaster ride of 2016. If equity markets continue upwards in 2018, it is unlikely to be in a straight line. Volatility is likely to be driven by bond markets which look expensive if interest rates rise more quickly than expected. As central banks begin the process of unwinding quantitative easing (or money printing) at a time when interest rates are rising, investors should be aware of the potential risks facing bonds.
By July if the market continues to go up, we’ll be in officially the longest bull market in history. Many feel the extended period of growth in the equity markets is justified due to the severity of the financial crisis that preceded it. Others will point out that due to the unprecedented accommodative policies of Central Banks around the world over the past decade; past indicators are of little use to forecasts.
The difficulty for investors is to always be forward-looking; we are constantly reminded that past performance is no indicator of the future. The difficulty is we all look at a market that performed well last year and think we have missed the boat rather than making an unadulterated assessment of the prospects today.
Sir John Templeton, a renowned investor with an eye for stock market value once said:
“Bull markets are born on pessimism, grow on scepticism, mature on optimism and die on euphoria.”
The most important tasks for investors in 2018 will be to figure out where we are on that timeline and position their portfolios accordingly.
This bull market feels closer to the end of its journey than to the beginning. That was also the feeling at the start of 1999: it did not feel good buying equities with high valuations and most of the growth being driven by one sector (technology) along with uncertainties surrounding the impending new millennium (remember ‘The Millennium Bug’). Whilst the bears were ultimately proved right, 1999 was one of the best years of that bull market.
The good news is analysts expect the market to continue to do well, with corporate spending and individual spending being the driving factors. The bullish case for stocks hinges on an economy that’s moving in the right direction, but not very forcefully. In 2017 the markets moved from one fueled by quantitative easing to one where it’s actual fundamentals (earnings growth, cash flow growth) that have driven the markets. For the first time in a decade, at the start of 2017 the world’s developed economies were all growing at the same time. Expect global synchronized growth to continue in 2018, The International Monetary Fund projects global economic growth of 3.7% in 2018.
Equity markets should be carried to new highs by a supportive macro environment in 2018. Headwinds are present though. The US economy is at risk of overheating, tighter financial conditions could slow the European recovery and Chinese growth stimulus seems likely to moderate following the 2017 Party Congress. Geopolitical risks related to North Korea or US trade relations could flare up at any time.
Ironically, what’s good for your pocket poses a threat to your portfolio. Were wages to rise enough to cut into corporate profit margins and lift overall inflation, it would signal an overheating economy and spell sharply rising rates and the beginning of the end for the bull market.
Complacency is a real risk. Volatility essentially vanished from the market in 2017, a development that can boost bullish sentiment, encourage excessive risk-taking and push valuations to extremes.
Still, investors weighing market risks will have to consider the cost of leaving even an expensive market too early.
Selection of investments becomes even more important at this stage of a bull run with an emphasis on high quality. Investors need to stay on a long-term horizon and think twice about buying anything you might want to get out of soon.
Outside of the UK
Almost a third of fund managers expect Europe to produce the highest returns next year, while almost a quarter picked emerging markets as the most promising area, according to a survey by the Association of Investment Companies (AIC), a trade body.
After a strong rally this year, the American stock market has lost some of its appeal for fund managers: it was seen as the most attractive region going into 2017 but has slipped to third place for the coming year.
Global stock markets have largely shrugged off the uncertainty and made good progress over the year. It’s a great reminder that if you’re prepared to look past the negative headlines, there are often decent returns to be made.
And as we move into the New Year, the general view of stock markets hasn’t changed. Interest rates rose marginally last year, but cash and bonds still offer little in the way of income. This means the stock market could offer a return on your capital – provided you’re happy with the inevitable rises and falls of the market.
Two demographic themes, Silver Economy and Millennials’ Values, tap the two biggest demographic drivers of many sectors and companies, population aging and the “coming of age” of the Millennials as consumers and investors.
Many feel corporate investment will finally pick up in 2018 as many are being forced to invest in areas like IT security and new production processes. Other companies, threatened by disruption, will have to acquire or merge to survive. The potential repatriation tax holiday for US companies could be an incentive to do so in 2018 rather than later. Healthcare and telecoms are identified as two key areas for M&A.
So the general consensus for stock markets seems to expect 2018 to be more like 2016 than 2017: at best a below average return with much greater volatility leading to significant dips along the way. The more experienced investors may look to increase returns by buying value on the lows but this is not for the faint hearted.
Talking of bull markets, many experts are predicting the 30-year bull market in bonds could be drawing to a close. With central banks taking measures to end the huge stimulus programmes, bonds could be in for a bumpy ride.
The outlook for bonds is dependent upon interest rates. If interest rates rise faster than expected then bonds will look expensive. The process of normalisation of interest rates in the major developed economies is, very slowly and gradually, getting under way, and interest rates look likely to rise in 2018, creating issues for bond investors.
Government bond markets have been repricing to a faster growth environment and a gradual reduction in central bank support. Will the current stimulus in the US lead to higher growth and inflation culminating in earlier rises in interest rates than currently priced into the bond market?
In addition to global economic consideration, the outlook for the UK economy is highly uncertain thanks in part to a wide range of potential Brexit scenarios.
Despite the expert warnings and the institutions pulling out of fixed-income funds, private investors in the UK have been piling in over the past six months. This in itself will be seen as a reverse indicator by many.
Private investors in the UK now have a total of £240 billion invested in fixed-income funds, almost three times what was held ten years ago. Bonds are seen as attractive by many investors as they can produce a yield far in excess of savings accounts for what is perceived as a ‘modest risk’.
A number of experts have called the end of the bond bull market over the last two years and been wrong thus far. The big question for investors is whether a higher interest rate risk now means fixed-income bonds should no longer be considered a ‘modest risk’.
Bonds tend to be held to diversify and balance an equity portfolio. With returns on bonds predicted to be low over the medium term, there seems little reason for investors to increase exposure and increasing focus on other investment opportunities.
The consensus seems to be a slow-down in London rather than a crash whilst value can be sought in other areas of the UK that have not seen the same growth over the past ten years. The overall trend for 2018 is for a low single digit rise.
Research from Nationwide shows that house prices rose by 2.6 per cent last year, compared with 4.5 per cent in 2016.
The East and West Midlands along with Scotland and Wales saw the largest appreciation in 2017 and still remain significantly below 2007 highs. A recent report by KPMG suggests Yorkshire, the North West and the North East will see some of the UK’s highest average house price growth during the next decade.
Regional disparity is expected to be significant again this year. Over the next five years Savills predict growth of 7.1% in London, compared with a rise of 18.1 per cent for the North West and 14.8 per cent for the West Midlands.
Property Hub predicts the top ten places for investment in 2018 as:
The more adventurous may look to diversify into international property with many predicting upside potential in the US residential market. This will have to be weighed up against possible fluctuations in Sterling as Brexit negotiations progress.
With investor caution regarding stock markets around the world, many investors will look towards venture capital amid predictions of greater technological change in the next decade than seen over the last ten years. This is quite remarkable when you consider the huge adoption of technologies since 2007.
In July, the five largest market cap companies on the planet were all venture-backed tech companies, including Apple, Alphabet, Microsoft, Amazon and Facebook. No.6, by the way, is Alibaba, also venture-backed technology, in China. The fundamental business performance of these companies has allowed them to pass the old guard of Berkshire, JPMorgan, and Exxon for the world’s most valuable companies. Despite this strong performance, the current technology sector seems fairly valued when compared to its median P/E ratio for the last 20 years.
Many companies, CSS Partners included, will be trying to identify companies at the forefront of new technologies. A number of commentators highlight ‘digital disruption’ as a theme to watch as businesses look to artificial intelligence (see article on Artificial Intelligence) and automation to open new markets or serve existing customers more efficiently. When investing in UK technology companies, many investors look to take advantage of the significant tax breaks available to investors through the Enterprise Investment Scheme if possible (for more information see Enterprise Investment Scheme).
Away from technology, mining stocks have been a success story of the past two years. The sector has seen profits and cash flow improve, and dividends payments return, driving share price performance. Following a strong 2017 the Mining Sector is likely to be supported by improved global economic growth and remains some way below the 2011 peak. This could present opportunities to invest in smaller mining stocks as the majors are likely to adopt acquisitive strategies to stay ahead.
Bitcoin has hogged the headlines with even the most cautious investors thinking ‘if only’? There is much debate over the future value of Bitcoin with opinion I have read varying between $1m and zero. As an investment, Bitcoin is too volatile for the vast majority of investors but it has served as a trailblazer and made the world aware of the benefits of cryptocurrencies.
The more cryptocurrency is used the more it will be accepted, which eventually will decrease volatility. All in all, it seems cryptocurrencies are here to stay so the question is how to invest in this embryonic market. According to Coinmarketcap there are now more than 1,400 digital currencies in circulation with a combined value of a staggering $704 Billion. The market is dominated by Bitcoin with Ether and XRP (or Ripple) the next highly valued.
Most of the major tech companies have taken someone else’s great idea, copied elements of it and then built a better version (see Keys to Success for Growth Companies). The likelihood is the same will happen to Bitcoin.
This prediction is more likely to happen due to blockchain, the technology behind Bitcoin (see previous article on Blockchain technology). Blockchain is a digital ledger hosted across a network of computers with all transactions verified across all the computers. Blockchain’s main strength is it decentralises the protocol, meaning its validation is through democracy rather than one central body. This becomes a hindrance if you want to address any weaknesses in the initial product as you will need approval of all the users to adopt any new improvements. This makes any changes almost impossible for a widely used cryptocurrency.
This is a major problem as the initial iteration of any new technology is likely to need significant improvement. If Amazon or Google had not constantly improved their initial products then they certainly would not still be market leaders and probably would not still be around.
Blockchain protocol is open source meaning anyone can see it and copy it. An entrepreneur who has an idea for a better, faster, more secure cryptocurrency will simply copy all the best parts of an existing currency, add their own spin, and start a new company. The currency that was copied won’t be able to defend itself by making the required improvements to compete and if the new product provides more value, users will switch to that product.
This is a cycle likely to be repeated many times until there is a dominant crypto-currency whereby marginal benefits of competitors are not significant enough to encourage users to switch. A number of crypto commentators speculate that the success of cryptocurrencies will lead to Central Banks issuing their own digital currencies, with even a co-ordinated currency issued by the G10 Central Banks a possibility. If this happens and the product is sufficiently advanced, the authority of such a currency would encourage wider adoption by businesses and this would surely sound the death knell for all competitors.
In the meantime, over the next few years many new cryptocurrencies will come along. Once a new currency starts picking up market share, there will be the opportunity to ride a sharp appreciation in the valuation until a new and improved competitor comes along. Out and out punters might look to ride these waves.
The information in this website is provided by CSS Partners LLP. This website has been approved for the purposes of section 21 of the Financial Services and Markets Act by Charles Street Securities Europe LLP (CSSE), which is authorised and regulated by the Financial Conduct Authority. CSS Partners is an appointed representative of CSSE.
Any views or opinions expressed in this blog are those of the author alone, except where specifically stated that they are the views of CSS Partners LLP.