Andrew Milligan, Head of Global Strategy at Standard Life Investments, tells us how global markets are performing in 2018. He also shares what assets he expects to perform well – and what potential challenges they might face.
In this month’s market review I look at how global markets are performing, what assets I expect to perform well and what potential challenges they might face. I also take a closer look at the important issues investors need to consider throughout the year.
We’ve been cautioning for some time now that a correction in equity markets would not be a surprise. Not just in the US but across the world.
Most countries have experienced significant upward moves to a greater or lesser extent over the past 12 months. But there have been definite signs from surveys of investor confidence, cash levels in portfolios and the relationship between the stock market and economic data that suggested some equity prices had moved too far, too fast.
However, a sell-off in the market just reminds investors of the inherent uncertainty from investing in stocks and shares. And, encouragingly, there are few signs that a major sell-off is likely, particularly given the backdrop of solid expansion in company profits, the way the world economy is motoring ahead, and no need for central banks to be aggressive in order to control inflation.
Sterling has rallied in recent months, which has important implications for many UK companies. However, investors should note that the rise in the pound is more of a reflection of the US dollar weakening than the UK economy strengthening.
For example, we saw the sterling/dollar exchange rate move up about 8% in early November-late January. But if we take a broader view of the pound against our major trading partners, it moved more like 4%.
Even so, a reassessment of the extent of the slowdown in the UK economy has certainly helped the pound rally, as have reduced concerns about the impact of Brexit and more signals from the Bank of England that interest rates may need to increase in 2018.
Looking ahead, we expect external rather than domestic factors to have a greater influence on the performance of the pound. As it stands, the UK still isn’t as attractive a destination for overseas capital as some other markets.
Following Trump’s tax cuts there will be an inflow of repatriated cash into the US economy. Where this money will be invested is one of the most important questions we face for the coming year.
For now, it’s uncertain. This is partly because senior management at US and overseas companies benefitting from the tax cuts are still analysing the full impact of the legislation. Markets would be reassured if much of the cash went into capital spending, lengthening this economic cycle.
However, it’s possible that these managements will instead start a new mergers and acquisitions campaign – for some firms it’s easier to buy a new factory or distribution system than build one from scratch. And, at a time of slowly rising interest rates in the US, many investors will also warn companies that higher dividend payouts and share buybacks are needed. This would create an incentive to buy equities rather than bonds.
At the moment the range of outcomes remains broad; stock picking requires insightful analysis.
One of our key questions when making an investment decision is what is in the price? Money markets are already assessing whether the Federal Reserve (the Fed) will move interest rates up three or four times this year. On top of the economic recovery and some signs of wages growth, we need to take into account the impact of the major package of tax cuts on the economy and public sector finances.
With all that in mind, we expect financial markets will only move significantly more than expected if there’s a sharp rise in inflation in the US. That, in turn, would suggest the Fed needed to be much more aggressive with interest rate rises than what’s already priced in.
Looking ahead, we expect bond markets to remain under stress in 2018. Pressures include strong growth, evidence of headline inflation, higher oil prices, and central banks withdrawing much of their quantitative easing.
As a result we’re underweight in most government and corporate bonds. The exceptions are some of the higher yielding emerging and US debt markets.
However, on the other side of the demand and supply equation, there’s still strong demand from institutional investors for bonds. For example, some pension schemes are actively looking for asset liability matching programmes.
All said and done, it would seem the markets have priced in a lot of bad news on future rate rises so we don’t expect a major sell-off in bonds to happen soon.
As we move forwards we expect equity markets, whether emerging and developed, to show positive growth in 2018. However, we don’t expect to see the same sort of performance as we saw in 2017; after all, emerging markets soared over 25%, last year. We also expect to see much greater day-to-day, week-to-week volatility in markets; early February’s price action is just such an example.
It’s worth recognising that 2017 was a rather unusual year. After all the last time the S&P 500 Index showed consecutive monthly increases over a whole calendar year was back in the early 1950s!
The views expressed in this blog should not be regarded as financial advice. The value of investments can go down as well as up and may be worth less than was invested. Information is based on our understanding in February 2018
Andrew Milligan is Head of Global Strategy at Standard Life Investments.