Quarter 4 performance
Returns were positive across the board in the final quarter, contributing to a very strong year for equity markets around the globe. Japan was the standout performer in Q4 following a resounding victory by Shinzo Abe in October’s General Election.
The UK, having lagged behind other regions for much of the year, experienced its traditional ‘Santa Claus’ rally in December, delivering a gain of nearly 5% for the month. The lowest gains came from the Eurozone where politics overshadowed strong economic data.
The US market had another strong quarter, with optimism for continued growth boosted by the passing through Congress of the long awaited tax cuts package, one of the few policy pledges to come to fruition since President Tump took office.
Emerging Markets continued to deliver superior returns with China, which accounts for 30% of the index, leading the way. China reported Q3 GDP growth ahead of expectations, along with strong earnings from technology stocks and the re-appointment of Xi Jinping as leader of the Communist party.
The Bull Market for equities rolls on
% total return
|Calendar year 2017
% total return
A ‘Goldilocks’ scenario has prevailed, with growth neither strong enough to stoke inflation, nor too weak to require action from Central Banks. Indeed, 2017 has proved to be a very rewarding year for investors who kept faith in markets through the various geopolitical challenges. The driving force was strong corporate earnings which vindicated some of the fuller valuations.
Over 2017, Emerging Markets were the standout performers, staging a strong recovery as investors dismissed risks of threatened US trade sanctions and recognised the superior growth prospects, especially in Asia. China is on course to beat its full year target of 6.5% GDP growth yet many stocks trade on reasonable valuations.
The S&P 500 Index finished the year up 21%, driven by the technology and consumer discretionary sectors, and marking its strongest performance since 2013. The momentum was maintained despite three interest rate rises during the year, albeit in line with expectations. These hikes failed to support the dollar which depreciated, reducing returns for overseas investors.
The Euro First 300 had its best year since 2013, gaining 11%, and the FTSE 100 rose 12%, closing at an all-time high on the last day of trading. Both were very respectable returns given the ongoing uncertainty surrounding the Brexit negotiations. Europe was the only region to produce higher gains in sterling terms, as the Pound recovered against all leading currencies with the exception of the Euro.
The price of Brent crude oil dipped in the first half but finished the year nearly 18% ahead, touching $67 per barrel in December. Prices were supported by OPEC and Russia-led production cuts and the effects of US hurricanes and outages in the North Sea. The Gold price also performed reasonably well, gaining over 12% in 2017, though rising real rates hurt Q4 performance. Meanwhile, cryptocurrencies, such as bitcoin, have attracted the attention of those with a greater appetite for risk, producing phenomenal gains but sparking fears of a bubble in the making.
Key events of the quarter
Austria elected the world’s youngest leader, 31 year old Sebastian Kurtz of the conservative People’s Party, as Chancellor. However, the far right Freedom Party had its best result for 2 decades allowing it to join the Government. Angela Merkel won the German election with a reduced majority but has struggled to form a coalition government. Regional elections in Catalonia saw independence parties claim a combined majority of the vote, bringing further uncertainty for Spain. Looking ahead, there are concerns that elections in Italy in March will show further evidence of the rise of populism.
The US Federal Reserve delivered a third hike in US interest rates, to a 0.5-0.75% range, in December. This contributed to a sell off in US Treasuries and had a knock- on effect on Government Bond markets elsewhere, with yields in the UK and Germany recovering from record lows. Trump’s proposed stimulus programme will require greater bond issuance putting further pressure on prices. In the Fixed Interest asset class, global high yield delivered the best returns as default risk faded, particularly in the energy sector.
Britain reached a divorce deal on Brexit. The bill to cover outstanding financial commitments could exceed £50bn over a number of years. Agreement was also reached on EU citizen’s rights and a deal for Ireland. There was a sense of relief and sterling strengthened.
In the UK, Chancellor Philip Hammond delivered his first Autumn Budget. He reduced Government estimates for GDP growth to 1.5% for 2017, 1.4% in 2018 and 1.3% in 2019, as investment and consumer spending slow due to Brexit uncertainty. Various investment programmes to tackle Britain’s low levels of productivity were unveiled and Hammond pledged the biggest annual increase in housing supply since 1970.
A snap general election in Japan resulted in a landslide victory for Shinzo Abe, giving him the necessary mandate to pursue his reform agenda. In China, the 15th party congress saw Xi Jinping secure a second 5 year term at the helm of the communist regime. Both outcomes were greeted favourably by investors.
Asia Pacific shrugged off several missile tests by North Korea, even though Pyongyang has suggested the latest are capable of reaching US territory. Protests against the Government in Iran, late in the year, have threatened to disturb peace in the Middle East.
Economic trends and outlook around the globe
In its latest quarterly World Economic Outlook, published in January, the IMF* edged up its global growth forecasts once again, to 3.9% for both 2018 and 2019. The upgrade reflects increased global growth momentum and the anticipated impact of the recently approved US tax policy changes.
The OECD** expects (as at November 2017) 3.7% growth in 2018, noting that policy stimulus is supporting the synchronised upturn while inflation and wage growth remain subdued. However, it cautions that low interest rates and lack of market volatility have encouraged risk-taking. Consequently, high levels of corporate and household debt could leave many countries vulnerable to shocks.
The IMF has maintained its growth estimate for the UK at 1.5% in 2018, while reducing its 2019 forecast slightly to the same level. The UK is the only major economy to be downgraded, with Brexit uncertainty blamed for our failure to participate in accelerating global growth.
Growth in 2017 was negatively affected by rising inflation which depressed household incomes and consumer spending. Household savings fell from 7.5% to 5.9% of income in the year following the referendum, so this support for retail sales is probably over. Bricks and mortar retailers have also suffered as the switch to online sales gathers pace.
Inflation hit a 5 year high of 3.1% in November, the level at which the Bank of England Governor has to write to the Chancellor explaining the overshoot. Higher import costs and a pick up in energy prices were key drivers behind November’s first interest rate rise in a decade. The increase, to 0.5% from 0.25%, was the first since June 2007, reversing the cut following the EU referendum. Further increases are likely to be modest.
Subdued wage growth contributed to a fall in real incomes for many. It is also blamed for low productivity growth, along with greater self-employment, technology and automation. There are few obvious catalysts for a pick-up in consumer spending, with real wages set to remain subdued. Brexit uncertainty needs to be resolved to prevent businesses putting investment plans on hold.
Nevertheless, high employment levels and strong export sales have offered some assistance to the UK economy. Steady quarter on quarter GDP growth of 0.4% in Q3 has continued into the 4th quarter, helped by a buoyant manufacturing sector. Growth in the UK manufacturing sector slowed in December, but strong performance the previous month meant the sector achieved its best quarter for three-and-a-half years at the end of 2017. However, it only accounts for around 10% of the overall economy.
The United States
The IMF has upgraded US GDP growth from 2.3% to 2.7% for 2018, and from 1.9% to 2.5% for 2019, reflecting the benefits expected from the tax reduction programme.
US Industrial production has bounced back strongly in Q4 from the disruption resulting from the hurricanes and flooding which affected output in the previous quarter. This should give a further fillip to corporate earnings which have already demonstrated impressive growth through the year, due to healthy consumer spending. Unemployment is at its lowest for 16 years while business and manufacturing confidence are at the highest for a decade.
A series of new record highs were set throughout the quarter driven by technology giants such as Alphabet, Facebook and Amazon, which reported forecast blitzing earnings figure. They should continue to outperform if the momentum rally continues. The implementation of tax cuts in 2018 should boost the wider US economy and in turn positively impact global economic growth.
The Federal Reserve new chairman, Jay Powell, is expected to continue the cautious approach to raising interest rates that his predecessor Janet Yellen adopted. Forward guidance is for three further rate hikes in 2018.
IMF growth predictions for the Euro area have been raised, by 0.3% in each year, to 2.2% for 2018 and 2% for 2019, following encouraging data and robust confidence surveys. Prospects have improved in Germany, Italy and the Netherlands as both domestic and external demand improve. Spain, however, has been adversely affected by the effects of increased political uncertainty on confidence and demand. The European Central Bank expects Eurozone growth to be 2.3% in 2018, a considerable increase on previous guidance of 1.8%.
Latest figures from Markit showed the European manufacturing PMI*** reaching its highest-ever level in December. Over the year the improving PMI outlook has increasingly been reflected in the official output figure which bodes well for the sector going forward. The composite PMI is consistent with GDP growth of above 2.2% which should positively impact corporate profits and equity markets.
Falling unemployment, improving policy reforms and reduced budget deficits across Europe are also providing a positive backdrop for growth. Business spending and retail sales have improved significantly. Early signs that inflation is picking up in the region, combined with the likelihood that the ECB won’t raise rates until 2019 are supportive for equity markets. It is two years behind the US recovery cycle.
Some uncertainties do remain as a result of ongoing social and political challenges. These include: Germany could return to the ballot box, Italian elections could see the rise of the Five Star movement and Catalonia’s relationship with central Government could deteriorate further.
The IMF forecast for Japan has been revised upwards, by 0.5% to 1.2% for 2018 and by 0.1% to 0.9% for 2019, reflecting improved external demand, the supplementary budget for 2018, and ongoing benefits of stronger-than-expected recent activity.
The re-election of Shinzo Abe in Japan has provided investors with reassurance that his programme of reforms will continue. Inflation is likely to remain low, allowing interest to be kept at minimal levels for the foreseeable future.
The desire to maintain loose monetary policy is likely to lead to another dovish Bank of Japan governor succeeding Kuroda. This should ensure a positive outlook for earnings growth, helped by improving corporate governance and pressure on companies to deliver Return on Equity above 8%.
Business sentiment is the best for eleven years as domestic and export demand give the corporate sector a boost. The Tankan Index for large manufacturers is suggesting robust growth in the final quarter.
This gives the economy the potential to grow above trend as exports and consumption expand, while unemployment remains at a twenty year low. GDP growth advanced at 1.4% annualised in Q4 and this look likely to improve further in coming months.
In emerging market and developing economies, the IMF expects unchanged growth of 4.9% in 2018, followed by 5.0% in 2019. However, there are marked differences across the regions, with Asia leading the way due to impressive growth from the mega-economies of China and India. China is expected to deliver growth of 6.6% in 2018, while India will advance by 7.4%.
Countries in the benchmark have varying levels of development and risk but overall superior growth prospects to developed markets. The largest economies of China and India are key drivers but many smaller countries, known as frontier markets, are growing rapidly.
China avoided the hard landing predicted by some economists for 2017, although corporate debt levels remain a concern. GDP grew by 6.8% in Q3, ahead of the full year target of 6.5%. President Xi, having secured a second five-year tenure, seems set to shift policy from a growth focus towards supply side reforms with, the aim of reducing debt.
India has made progress with its pro-business reform agenda, which has lead to ratings agency Moody’s upgrading its local and foreign currency sovereign bond ratings. Plans to recapitalise Banks were received positively by investors. The roll out of the Goods and Services Tax (GST) and anti-corruption measures should contribute to reducing government debt as corporate earnings pick up.
In Latin America, the recovery is expected to strengthen, with growth of 1.9% in 2018, forecast by the IMF. Improved outlooks for Mexico and Brazil will more than compensate for downward revisions to Venezuela. Brazil’s recovery is becoming broader based; falling unemployment, wage growth and lower interest rates have assisted domestic consumption. However, measures are needed to stabilise the fiscal position and boost business confidence.
Emerging markets may not repeat last year’s exceptional returns but still have potential to outperform. Demographics are likely to be more favourable for many years to come and the prospect for both capital and dividend growth is attracting overseas investors. However, potential headwinds remain: a slowdown in China, global liquidity tightening and protectionist US trade policies.
Prospects for stock market investors
In 2017 markets have overlooked geopolitical noise and focused on fundamentals, notably the corporate earnings which underpin valuations. Failure to meet expectations is harshly punished, a scenario which should reward successful stock-pickers. Consequently, it will be important to choose your Fund Manager carefully as there will be winners and losers in each asset class.
The New Year has again begun on a positive note, with several regions breaching new highs. Last year proved a valuable lesson in the risks of attempting to time the market, which did not react to events in the way many expected. A lot of investors, including seasoned professionals, have built up high cash levels. For those looking to invest, equities were the preferred asset class due to attractive and growing dividends and some prospects for capital growth.
Valuations remain demanding in many areas, notably the U.S. and if the expected growth does not materialise they may be vulnerable to a sell-off. Until there is a clearer picture about the Brexit negotiations, UK growth is likely to lag the continuing recovery in most other countries and the outlook favours Japan, Europe and Emerging Asia. However, any favourable trade deals for the UK could open up an opportunity for stocks which have been overlooked.
While bonds and growth stocks undoubtedly look pricey, Fund Managers report plenty of attractive opportunities and we could see a rotation into sectors offering better value. If inflation and bond yields pick up, this will favour a value style over growth and defensives. The upturn in the commodity price cycle should assist companies in these important sectors, while the oil price should be supported by further supply cuts. The financial sector also has significant recovery potential if a healthy economic outlook is reflected in lending growth and interest rates edge upwards.
The potential for attractive and growing dividends remain one of the key attractions of investing in equities. The third quarter increases on the back of broad based global recovery led Janus Henderson to upgrade its forecast for global dividends to +7.4% for 2017. However, it is worth remembering that in the UK just 10 companies account for nearly all the dividends from the FT All Share, and dividend cover is just 1.5 times. In contrast, Asian dividends are covered over 4x by earnings, while Emerging Markets dividends are growing by 30%. This implies lower risk and higher growth for income seekers may be available overseas.
In conclusion, we can expect a modest acceleration in developed world growth and a soft landing in China. As 2018 begins, the activity picture remains strong. Business is confident and leading indicators signal robust growth ahead. We should expect to see new technology transform the productivity of some traditional industries.
Although the outlook is optimistic, more risk adverse investors may wish to protect against potential downside and prepare for greater volatility. The growth outlook should theoretically favour equities over bonds but any earnings disappointments or unforeseen events could see money flow back into bonds reminding us of their role as a defensive asset class and an important diversifier in your portfolio.
More than ever it is important to ensure you have a portfolio that is aligned with your appetite for risk. Don’t be put off by short term disruption and remember that investing is for the medium to long term.
*International Monetary Fund
**Organisation for Economic Cooperation and Development
*** Purchasing Managers Index
Important Information: We do not give investment advice so you will need to decide if an investment is suitable for you. If you are unsure whether to invest, you should contact a financial adviser.