Market behaviour will continue to puzzle economists and investors in 2018, much as it has done over the last 12 months, according to Jupiter Vice-Chairman Edward Bonham Carter. “We should be able to expect reasonable investment returns if inflation stays contained and US interest rates follow a slow and steady upward course,” he added.
Over the last 12 months, economies and investment markets have been behaving in ways that have been confounding investors and economists alike. There is little reason to think that won’t continue to be the case in 2018.
A major challenge has been rising stock markets around the world despite a string of news headlines that would, in normal circumstances, have reduced investor appetite for riskier assets such as shares. Donald Trump’s unorthodox presidency, tricky Brexit negotiations, rising nationalism in Europe, continuing unrest in the Middle East and an unstable Korean peninsula have provided the backdrop to this year’s stock market gains. While markets have remained calm, situations that appear contained can quickly flare up, prompting markets to fall. It will therefore be more important than ever to remain vigilant to these geopolitical threats in the year ahead.
It’s all getting a bit pricey
Even more perplexing is that markets, by and large, are not cheap. Many major stock market indices, including the FTSE All-Share Index, the S&P 500 Index and the MSCI Emerging Markets Index, are all trading close to their historic highs.
It is this combination of troubling news headlines and high valuations that makes this stock market rally, in my view, a mirthless one, and potentially one that is ripe for a reversal. There is a sense that the party cannot go on for much longer, and there is much talk in the market that this year will be a more challenging one. We’ve heard such predictions before, especially from those who are under-invested in the market and are looking for prices to fall so they can jump in, but this time, arguably, there is greater reason to think it might actually occur.
Inflation needs to behave
Economic growth is likely to remain supportive for markets in 2018, with developed economies famously enjoying a Goldilocks moment, with growth not strong enough to stoke inflation, but not too weak to see higher unemployment. Yet, the outlook for inflation is likely to remain a source of concern in 2018. There is a question mark over how long wage growth can remain subdued in countries like the UK and the US, with labour markets being so tight. The labour force’s bargaining power on wages is much less strong than in the past, as people are effectively importing cheap labour as they buy increasing amounts of products online that have been manufactured abroad in low-wage countries.
Technological innovation, meanwhile, continues to make inroads into all areas of the global economy, capping or driving down the prices of goods and services. Should inflation pick up, we can expect the US Federal Reserve and other central banks to quicken the pace of interest rate rises.
A delicate balancing act
In this scenario, the year ahead could prove very different from the ones we have recently experienced. A rising interest rate environment would favour shares over bonds, but market confidence may be shaken as higher interest rates send more companies and individuals into bankruptcy and act as a brake on economic growth. For a long time, the price of many investments has been distorted by central banks cutting interest rates and using bond-buying programmes (known as “quantitative easing”) to boost growth. Any attempt to bring interest rates back to their historical averages may prove painful, especially if it is done too quickly. Given how long rates have been kept low, when we talk about a reversion to the mean, the question remains what “mean” do we mean? Do we take a 10-year or 20-year historical average, or do we go even further back? That is one more conundrum for 2018.
On balance, though, central bankers are likely to inch rates higher to prevent extinguishing the economic growth they fought so hard to stoke with quantitative easing. Nevertheless, vigilance and a diversified asset allocation should help investors control these risks. If I have one final thought it is that, while it is only human to want to look at investing in terms of annual cycles, markets are in fact a continuum, and it is easy to forget some of the long-term trends that are driving investment markets: ageing demographics in the West, but a young demographic in emerging markets; the rise of artificial intelligence; a resurgent China and a United States, that for all its current troubles, still remains one of the most innovative economies in the world.
Shares, in that context, should be able to post reasonable returns so long as inflation doesn’t spike and we see a slow but steady rise in interest rates. Markets, as we have already mentioned, are close to their historical highs, a factor that may further constrain what returns can be achieved in 2018. For bonds, the key, in an inflationary environment, is flexibility. A strategy that is able to invest in all areas of the bond market has a better chance, in my view, of weathering what may prove to be a tricky year for bonds. Long-term investment trends, meanwhile, favour emerging markets, but, as ever, resolve will be needed to ride out the inherent volatility of the maturing economies that underpin them.
This document is for informational purposes only and is not investment advice. Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested. We recommend you discuss any investment decisions with a financial adviser, particularly if you are unsure whether an investment is suitable. Jupiter is unable to provide investment advice. For definitions please see the glossary at jupiteram.com.
The views expressed are those of the author at the time of writing, are not necessarily those of Jupiter as a whole and may be subject to change. This is particularly true during periods of rapidly changing market circumstances. Every effort is made to ensure the accuracy of any information provided but no assurances or warranties are given.
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Important Information: Willis Owen 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.
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