Detailed Market Outlook Report – January 2018

Detailed Market Overview

January 2018

London’s stock markets finished the trading year in style, shrugging off jitters over Brexit to bow out at record highs.  The FTSE 100 index capped the year with its 24th record close, up 64.89 points, or 0.85 per cent, at 7,687.77 (up 7.6 per cent on the year), while the more domestically focused FTSE 250 also hit a new peak, rising 83.95 points, or 0.41 per cent, to 20,726.26.  The pound appreciated against the dollar by about 10 per cent during the year, its strongest performance since 2009.  And sterling has recovered from its lows against the euro; in August it was trading at about €1.08 and is now at €1.15.

So the FTSE 100 ended the year making history by notching up its 24th record high of 2017.  Over the 12 month period, London’s leading index rose by almost 545 points, or 7.63 per cent, adding £141 billion of value, while the FTSE 250 finished almost 14.7 per cent higher, a rise of £52 billion.  The London Stock Exchange estimates that its value has grown by £141 billion.  It was the second successive year in which the FTSE 100 has closed the year at a record high, after it gained 14.4 per cent in 2016.  Nevertheless, City experts believe that there is more to come (see below).

Britain’s record-breaking run formed part of a boom year for global equity markets, built on rising corporate profits, higher commodity prices and cheap money.  The MSCI[1] world index of equities, comprising 47 countries, rose by 22 per cent, adding $9 trillion in value since the start of the year.  The American, Japanese and Hong Kong markets all comfortably outperformed London.  Boosted by President Trump’s end-of-year tax-cutting package and promised infrastructure spending blitz, the Dow Jones industrial average, S&P 500 and Nasdaq were all heading for annual gains last night of 20 per cent or more.

Asian markets largely disregarded the US president’s sabre-rattling over North Korea and threats of trade wars and focused instead on strong demand for technology stocks.  The Hang Seng index in Hong Kong leapt by 36 per cent and the Nikkei 225 in Japan recorded its sixth successive annual rise to complete a 2017 gain of 19.1 per cent, closing the year at 22,764.94.

China’s stronger-than-expected performance during 2017 has confounded those who predicted a “hard landing” for the engine room of the global economy.  It has led to stronger demand for commodities such as copper — a fairly reliable proxy investment for global growth, because of its use in products such as electrical wire.  The 4.9% rise in the FTSE 100 in December was driven by the copper price hitting a four-year high, which pumped up mining stocks.  The final half-day of trading in December highlighted one of the themes of the year — soaring mining stocks.


The CAC 40 in France, up 9.3 per cent, and the Dax in Germany, 12.5 per cent higher, both outperformed the FTSE 100.  The FTSE All-World index, an important global benchmark, jumped 22% over the past 12 months — its biggest increase since 2009.

Venezuela had the best performing stock market last year, up by an official 3,883 per cent. Yet things were not what they seem.  The government has a fixed exchange rate of ten bolivars to the dollar, but on the black market the currency has collapsed by 97 per cent.  The upshot?  On paper, Venezuelan stocks look to have stratospheric values. But try selling shares for hard currency and reality dawns. At the black market rate, stocks rose 18 per cent.

As previously mentioned, although the FTSE 100 ended 2017 at up by 7.6 per cent and at a new peak for a second consecutive year, London lagged behind many other leading markets, including those elsewhere in Europe.  More broadly, Britain’s equity markets have underperformed their continental counterparts in part because of the rebound in the price of sterling against the US dollar.  The pound was sold off in the wake of the Brexit vote in June 2016, but it rose last year as divorce negotiations with Brussels progressed.  The FTSE 100 is heavily weighted towards multinationals, which operate global businesses and earn foreign currencies.  A strengthening in the value of sterling makes our exports more expensive.

In addition, while Britain has fallen down the pecking order of the fastest-growing developed economies, Europe defied expectations by mounting an impressive recovery last year.  Whilst some uncertainty remains, but the outcomes of potentially disruptive elections in Germany, the Netherlands and France were largely benign for the markets.

Over the past year, our model investment portfolios have benefitted from our diversified, strategically proportioned exposure to selected global markets, producing significant returns for our clients.  Below, we outline our expectations for Global markets in 2018.

Expectations for Global Markets in 2018

As we start 2018, the outlook for the world economy looks to be the most favourable we have seen since before the global financial crisis.  The International Monetary Fund (‘IMF’) and the Organisation for Economic Co-operation and Development are forecasting world GDP to increase by 3.7 per cent for this year, which would make 2017-18 the strongest two growth years since the shortlived post-crisis bounce in 2010-11.  At the recent annual meeting of the World Economic Forum, the IMF raised its global growth forecasts for this year and next and proclaimed the “broadest synchronised global growth surge since 2010”.  The IMF upgraded global growth figures for this year and next from 3.7 per cent to 3.9 per cent and revised its estimate for last year from 3.5 per cent to 3.7 per cent — the strongest statement for economic prospects since the 2008 financial crash.  Most private sector forecasters share this positive growth outlook and some are even more optimistic.

Unemployment has been falling in most big economies.  The average unemployment rate across the G7 group of advanced economies is forecast by the IMF to be below 5 per cent this year for the first time since the 1970s.  All this is taking place against a background of fairly subdued inflation.  Consumer price increases are expected to average just below 2 per cent in the G7 economies this year, in the comfort zone for central bankers. Even in the UK, where inflation has recently breached 3 per cent, it is expected to fall back gradually this year. 

This positive economic picture has emerged from a political fog that appears to have engulfed the western world, starting with the Brexit vote 18 months ago.  Since then President Trump has arrived in the White House and there have been a number of surprising or inconclusive election results in Europe, including in the UK.  On the international stage North Korea has been flexing its military muscle with nuclear missile tests and the Middle East continues to be a source of potential instability.

Consumers and businesses in most leading economies, however, do not appear to have been fazed by these political developments.  It is consumer spending and business investment that are the main drivers of global growth, not the dramas that take place on the political stage.

The political developments over the past 12 to 18 months have been mixed news for consumers and business.  Brexit has clearly had a negative impact on the UK economy as a falling pound squeezed consumers through higher priced imports and investment uncertainty increased but the reaction to news in the US and France has been much more positive, with the prospect and implementation of pro-business economic reforms.

Three other factors are supporting the positive outlook for the global economy this year.  First, all the major regions of the global economy (North America, Europe and Asia) are performing reasonably well and contributing to global economic growth.  The most impressive turnaround in economic fortunes in the past few years has been in Europe.  The euro-area economies are growing at 2.6 per cent, faster than the US or the UK.  The latest figures show that more than 200,000 jobs have been created every month in the eurozone over the past year.  Our model investment portfolios have benefitted from Europe’s economic recovery, with strong performance form our long-term European funds.  Based on market expectations for the coming year, we will be strengthening our exposure to the eurozone for 2018.

Second, the global economic recovery, which started in mid-2009, is now into its tenth year.  That means that households, businesses and financial institutions have had a long period to improve their financial positions and memories of the shocks of the financial crisis are becoming more distant.  This provides consumers and businesses with more confidence that they can continue to increase their spending and investment even though living standards have not been rising as strongly as they did before the crisis.

Third, monetary policy in the western world remains highly supportive of economic growth.  Even though the US Federal Reserve has recently pushed its benchmark interest rate up to 1.5 per cent and the Bank of England has returned its key borrowing rate to 0.5 per cent, interest rates remain very low by historical standards.  The euro area benchmark rate is still 0.05 per cent.  In the US gradual interest rate rises have not so far had any noticeable negative impact on growth, and I believe the same would have been true in the UK if the Bank of England had followed a similar policy.

The cumulative impact of a long period of very low interest rates, alongside large injections of quantitative easing, is interacting with other positive features to reinforce the current recovery and to push up asset prices.  With growth picking up against a background of low unemployment, central banks should now start to be more vigilant and gradually withdraw the monetary stimulus injected during the financial crisis.

2018 looks likely to be a good year for the global economy.  Forecasters are betting that the strongest global growth in years will add extra fuel to the lengthy bull market, despite the gradual withdrawal of stimulus by leading central banks.  In the UK that will help to moderate the current consumer and investment squeeze related to Brexit and keep our economy growing.  In other major economies we are likely to see much stronger growth rates.

Can this period of healthy global growth be sustained?  The IMF is forecasting a continuation of 3.7 to 3.8 per cent global economic growth until 2022.  That would take the current economic upswing, which started in 2009, to at least 13 years: not inconceivable but not guaranteed either.  Since the Second World War global upswings have lasted between 25 years, from the late 1940s until 1973, and five years (in the late 1970s).  The 1980s economic expansion lasted for nine years and the global recovery, which started in 1993, continued until 2007, a total of 15 years.

Is the FTSE100 about to crash?

UK

The general consensus is that the FTSE 100 is headed for further modest gains in the coming year, despite the surge last month that carried the blue-chip index to a record high of 7,687.77 at the close of 2017.  Nearly all City forecasters expect the FTSE 100 to rise in the coming year, but not to match last year’s 7.6% increase.  The average prediction for the end of 2018 among the investment banks surveyed by The Sunday Times is 7,783 points — an increase of just over 1%.  Russ Mould, a director at AJ Bell, a stockbroker, said: “A lot of people have pencilled in 8,000 for the FTSE 100, and it is not that far away.  Predictions are for 10 per cent profit growth and 8 per cent dividend growth for 2018.”

US

Wall Street analysts rushed to raise their 2018 forecasts for the S&P 500 index at the start of this month, on the back of the fiscal stimulus promised by Donald Trump’s tax cuts. 

The American economy is showing signs that it could hit President Trump’s ambitious growth target after a report indicated that factories in the United States had enjoyed their best year since 2004.  The Institute for Supply Management’s manufacturing index, published this month, showed that factory activity in the US climbed to a reading of 59.7 in December, meaning that the average reading for 2017 was the best since 2004.  Growth expectations for the US this year have been heightened by the passing of sweeping tax cuts shortly before Christmas.  Economists estimate they could add as much as 1.3 percentage points to growth in 2018. 

Meanwhile, factory output in the United States was at its strongest in nearly three years last month, the manufacturing purchasing managers’ index from IHS Markit showed.  Output was revised up to 55.1 this month from a preliminary reading of 55.0.  A separate report this month showed that spending on construction projects in the US hit a 13-year high in November, rising to $1.26 trillion.

Europe

For the first time in a decade, economic forecasters appear to be unambiguously optimistic about the prospects for the eurozone economy. Perhaps that’s not surprising, given how badly wrong-footed they were by the strength of the recovery in 2017. A year ago, the European Central Bank was forecasting growth last year of 1.7 per cent, while the consensus among independent forecasters was 1.3 per cent. Yet the ECB now reckons that the eurozone grew by 2.4 per cent in 2017. Given that this was the fourth consecutive year of economic growth, ECB board member Benoît Coeuré insists that this should no longer be called a recovery but an expansion. Some even call it a boom.

Certainly the latest data points to a very strong start to the new year.  Business and consumer confidence in the eurozone are at their highest levels since 2001, according to the European Commission’s economic sentiment indicator, while the latest surveys of purchasing managers show optimism among manufacturers at record levels and export orders at new highs.  Growth is increasingly self-sustaining, fuelled largely by domestic demand and underpinned by the strongest run of job creation since 2000.  Eurozone unemployment is now down to 8.8 per cent from a peak of 12.7 per cent and falling fast. German firms reported a record rise in hiring intentions in December; Spanish unemployment similarly fell by one percentage point in the same month.  An expanding labour market leads to rising consumer spending and investment — a virtuous circle.  Perhaps the bigger risk to the eurozone outlook is that forecasters have once again underestimated the strength of the economy.

Reeves Model Investment Portfolios

As reflected in the graph below, all of our model investment portfolios have performed better than the FTSE All-Share Index benchmark during January.  Each model portfolio has performed as one would expect, reflecting the inherent risk-reward trade-off associated with different risk profiles; i.e. the higher risk portfolios have performed better in the ongoing bull market.

 

The proactive management of our clients’ pension investment funds is a crucial part of our service and the level of resources we devote to this area is rare, if not unique, within the UK IFA market.  The Reeves Investment Team meeting this month reflected on the various market predictions for 2018.  Predominantly, forecasters are betting that the strongest global growth in years will add extra fuel to the lengthy bull market.  2018 is expected to be the best year for growth since 2011, despite the gradual withdrawal of stimulus by leading central banks.

In a recent poll of investment trust managers, Europe and emerging markets were the two regions tipped to produce the best returns in 2018.  In the poll, conducted by the AIC, the trade body for investment trusts, 30 per cent of managers chose Europe as their preferred region, while 23 per cent picked emerging markets.  Whilst our current model investment portfolios already have a proportionate exposure to Europe, we have been underweight in Emerging Markets and this is something that we had previously identified and have now addressed as part of the strategic portfolio changes made during this month’s Reeves Investment Team meeting.  It is worth highlighting that the one existing merging markets fund we had already incorporated in our model investment portfolios (Blackrock Frontiers Investment Trust PLC) was the best performing fund in its sector (up 26.3% over the past year and 11.6% over the past month alone).

As well as increasing our exposure to emerging markets & Europe, we have reduced our cash balance and sold our direct exposure to the oil market (selling the ETFS Brent Oil 1 month ETC), taking gains from the recent oil price recovery.  We have also sold the Target Healthcare REIT Limited, after losing patience with its consistently poor performance.  Other portfolio adjustments include strengthening our exposure to the European market increased holdings in our selected European funds.  As a counter-risk measure, we have also increased our holding in the Investec Cautious Managed fund and our exposure to Gold via the ETFS Physical Gold fund (interestingly, speculative Bitcoin investors have been seeking refuge in gold after Bitcoin’s 40 per cent collapse over the past month raised questions over its future and that of other virtual currencies).  Clearly, gold remains the first instinctive port of call as a safe haven whenever market sentiment turns negative.  We therefore wish to retain a core holding in Gold as a contingency measure, should global equity markets take a sudden and unexpected downturn.

Therefore on balance, we remain optimistic about the prospects for global markets in 2018.  Nevertheless, we are conscious of the inherent risk of a sudden market correction, which some commentators suggest may happen sooner rather than later.  For this reason, we have retained a proportion exposure to cautious funds, gold & cash, to mitigate this risk.  We believe this is a sensible and prudent approach to pursuing positive returns for our clients, without exposing valuable pension funds to disproportionate or extreme risk.

Email communications will be going out shortly to those clients whose investment portfolios are affected by the recent strategic changes.  These latest adjustments are aimed at continuing to deliver positive investment returns through 2018 and beyond.