Despite some encouraging signs for the global economy, high valuations and political headlines have spooked many investors into taking profits, causing global market fluctuations over the summer. Meanwhile, in the UK, the markets face a complex set of variables. Andrew Milligan, Head of Global Strategy at Standard Life Investments, looks past the confusion to the real factors that could impact your investments.
Headlines caused some investors to ignore strong fundamentals
Major market indices waxed and waned over the summer with many investors deciding to take profits from their holdings. A combination of factors caused this trend; investors are in an environment where share prices are over-valued in some cases and where we’re between the quarterly reporting seasons that shed light on corporate earnings. So any concerning political headlines, of which there were many (such as North Korea or events in the White House), were enough to spook investors into raising some cash.
This is a short-term reaction to market ‘noise’ rather than to fundamental economic and business indicators. We continue to believe that profits growth will be buoyant in 2017 and 2018 on the back of decent, if not robust, expansion in the global economy – and so Standard Life Investments remain overweight in equity markets. That said, we need to look more carefully for good value in the current environment…
Finding value in an expensive market
Currently none of the investment asset classes look cheap in absolute terms, with a few exceptions such as some of the emerging market economies. However, on a relative value basis we favour the US, European and some Asian equity markets over and above Japan and the UK. In fixed income markets we continue to look for yield opportunities, so we prefer emerging market debt and some high yielding bonds to standard government bond markets. We’re also now neutral in asset classes which we previously liked, such as commercial property or investment grade corporate bonds.
Brexit and a bemusing UK economy
Brexit negotiations are now into complex territory, as we saw from the spate of position papers from the UK government over the summer. News headlines and much commentary are likely to follow the various meetings with EU officials – which in turn may encourage short-term currency volatility.
What about the longer-term picture? It still shows a slowing UK economy, which is being reflected in the prices of domestic sectors of markets. Two adverse trends are driving the slowdown: the impact of the lower pound on inflation, and the effect of weaker business confidence on investment. It will take time for these trends to reverse.
The Brexit-specific trends are part of an overall UK economic situation that’s challenging the minds of economic forecasters. These are some of the mixed signals investors face currently:
- We have growing employment but flat wages.
- Higher inflation has been hurting consumers’ real incomes and households have run down savings or borrowed to compensate.
- Service sector firms are working out the impact of Brexit on cross-border regulation and locations, while manufacturing exporters gain support from the lower pound.
- Even the Bank of England is showing their quandary – shown by the mixed signals from the Monetary Policy Committee (MPC) on what they’ll do next with interest rates.
All this means we’re focused carefully on using scenario analysis to determine the potential risk to markets and investments if Brexit negotiations falter or break down.
For investors, I’d say the key takeaway is that we expect slow growth in the UK into 2018. This is one reason why we prefer companies in other countries; unless it’s a UK company that can benefit from strong exports growth or which has a considerable overseas operation.
Questions over China
We all know China’s might as a global growth engine and the ripple effect it can have on other economies or commodity markets. According to the IMF, China has a massive debt of around £22 trillion – up from £4.6 trillion in 2008. So does this debt now threaten the global economy or is China well placed to control it? It’s one of the most important questions for investors over the next few years but also one of the most difficult to answer.
On the one hand, most emerging market economies which have suffered this pace of debt expansion have had problems afterwards; remember the Asian crisis of 1997-98 for example. However, China is different – it runs a current account surplus, its overseas debt is low; the government still largely controls the banking system, and is taking many more steps to regulate the so-called ‘shadow’ banking system.
The question facing President Xi, therefore, is where next? In 2018 does he regulate the economy more or liberalise more, reform key sectors more or expand the economy more? Interested investors should pay attention to the results of this autumn’s Chinese Communist Party Congress. I’ll be keeping an eye out for implications of President Xi’s decisions and will give you another update as things progress.
If you have any questions about your investment strategy, your 1825 Financial Planner will be happy to help.
The information in this blog or any response to comments should not be regarded as financial advice. Please remember that the value of your investment can go up or down, and may be worth less than you paid in. Information is based on our understanding in August 2017.