Looking back over the first six months of the year, 2017 has carried on from where 2016 left off, with big political events grabbing the headlines. So far we’ve experienced President Trump’s inauguration and his self-proclaimed ‘modern day presidential’ approach to office, the triggering of Article 50 to begin the official process of separating the UK from the EU, numerous elections in Europe where potential populist candidates were running and, finally, the Conservative Government’s loss of its majority.
By comparison the financial markets have been relatively sanguine and appear to have taken these events in their stride. The most striking evidence of this was the VIX Index (commonly referred to as the ‘Fear Index’) recently closing at its lowest level since 1993. But what has been the experience of the fund managers on the frontlines who have had to navigate all of this ‘noise’ whilst making investment decisions?
In this article we’ll hear from Aberdeen Asset Management, J.P.Morgan Asset Management, Schroders and Standard Life Investments on their mid-year outlook for 2017 and what they’ve learned so far.
According to Standard Life Investments: “One important lesson to learn from the first half of 2017 is to pay more attention to economic, and especially to corporate, fundamentals, and less to political issues.”
This view is echoed by Dr. David Stubbs, Global Market Strategist at J.P.Morgan, whose key learning from the first half of 2017 is to: “Invest in fundamentals, not rhetoric”. He elaborates: “Despite little positive policy changes, equity and credit markets rallied in the first half of 2017 as the global profit cycle has continued to improve.”
Standard Life Investments continues: “Of course, politics can create short-term volatility and uncertainty in markets. We saw this with worries about possible trade restrictions from the Trump administration or the prospect of electoral success for Marine Le Pen in France. However, while currency markets waxed and waned in reaction to opinion polls, global businesses were reporting much stronger profits growth as the world economy recovered with few signs (so far) of accelerating inflation to trouble central bankers.”
Nick Kirrage, co-head of the Global Value Team at Schroders, offers a more cautionary view: “There are very few times in history where markets have been more calm – something that should leave investors deeply concerned. Economist Hyman Minsky once wrote ‘The illusion of stability of the system will, over time, create its own instability‘. We would certainly argue the stability many equity investors have sought in so-called ‘bond proxy’ stocks is wholly illusory. The gap between the valuation of those bond proxy companies, which plenty of investors are still using as a comfort blanket, and everything else is growing wider and wider – as is the dislocation between the current market trajectory and the whole of the rest of history.”
Key drivers for markets
Standard Life Investments believes: “Many of the factors that drove markets in the first half of 2017 will remain important drivers of investor sentiment in the months ahead. Should we continue to see evidence of sustained economic recovery and improving corporate fundamentals then this will be positive for risk assets. However, political risk will remain prominent, with elections to come in Germany, and potentially Italy. Investors will also have to keep a close eye on policy developments in the US, especially for signs that the Trump administration might be unable to push through pro-growth legislation, the prospect of which has helped push risk assets higher in recent months.”
And at Aberdeen Asset Management the overall outlook remains positive: “As reflected in our small overweight allocation to equities. Stock markets have risen to all-time highs in several countries in recent months, making equities look more expensive, but the strong economic growth that is evident in most parts of the world is giving us confidence to retain these positions.” However, Aberdeen is of the similar belief that political uncertainty presents a potential cause for concern: “In the US, the Trump administration is beginning to face challenges in implementing its ambitious programme of reform. As a result, the recent confidence that has lifted share process could wane.”
What does the outcome of the UK election mean for markets?
Nick Kirrage at Schroders explains: “We understand that politics can be an important consideration for many investors and the ‘unexpected’ election result may cause concern for some. As value investors, however, any short term events – be they political or economic – will have little effect on our portfolio decisions.
“Of course we are mindful of the possible impact – we don’t live in a bubble. The stock market will inevitably react, moving share prices up and down depending on their estimates of the winners and losers from the situation. However, the true fair value of businesses changes very slowly over time.”
Aberdeen shares initial views: “Although the immediate market response to the result has been muted, we believe the medium-term implications are less clear. So far, equity investors have been relatively sanguine. The FTSE® 100’s high weighting in companies earning the majority of their profits overseas continues to give some protection from domestic political or economic concerns. Gilt yields are virtually unchanged, suggesting bond investors are also fairly untroubled by the outcome. Investors have had to get used to political uncertainty across global markets in recent years. For the moment at least, they seem to be taking the election result in their stride.
“On that note, investors have taken the view that Brexit will impair the UK’s trading prospects and weaken growth in the long run. However, the pound’s weakness should help net trade by boosting exporters and encouraging UK consumers to switch to domestically produced goods in response to higher import process. This should boost the economy in the relatively short term but it’s important to remember though that sterling has weakened precisely because the economy is expected to be worse off in the long run. So it would be a mistake to expect sterling’s depreciation to end in a net long-run boost to the economy.”
The challenges that lie ahead
Although there’s an economic recovery in the global economy, for Standard Life Investments it’s very clear that this remains a world of low numbers, in terms of growth, inflation and interest rates: “The US bond yield can be seen as a global benchmark, and oscillating currently between 2% and 2.75% it hardly suggests a very strong outcome ahead. Low returns with low volatility, or high returns with high volatility, that is the choice for investors in mainstream markets.”
According to Nick Kirrage, Schroders: “The average holding period for equities has fallen tenfold since 1950, and there’s plenty of evidence to suggest short-termism can lead to higher costs and lower returns. There is one benefit of this trend however, and that is the more short-term the broader market becomes, the greater the potential benefit to those who are able to adopt a more patient, longer-term investment strategy. By having a genuine 3-5 year time horizon we are able to invest in businesses that others are simply unable to pursue, and in doing so we could reap the long-term rewards.”
Dr Stubbs at J.P.Morgan is of a similar opinion, warning that: “The biggest challenge for investors is to find attractively valued asset classes with the potential to deliver above inflation returns in the medium term, and to avoid the behavioural biases which can limit their exposure to retrains over the long run.”
Where can investors find the best opportunities?
Currently Standard Life Investments believes: “The best returns will come from global equities. However, the decisions we make on which countries or regions to invest in will very much depend on what is priced into the market in terms of future profits growth, as well as the impact of currency movements. We favour Japan and the UK less than other markets and from an income perspective, we continue to favour emerging market debt and US and European real estate. As ever, a focus on underlying economic and corporate fundamentals will be a key driver of what we consider the most attractive investment opportunities.”
J.P.Morgan also believes emerging market equities and debt seem to have the best combination of yield, valuation and momentum at this point. Whereas, Aberdeen does see “opportunities in Japanese equities, given the ongoing efforts by Japan’s government and central bank to ward off deflation.’
As we can see from the comments above, events that cause big headlines from a political point of view don’t necessarily filter through to markets as anticipated. It is, however, important not to become complacent given the current environment we find ourselves in, as volatility will return at some stage. That’s why at 1825 we continue to recommend that our clients take a long term investment view and make sure that their portfolios are well diversified across a number of asset classes in line with their appetite for risk.
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. Past performance is not a reliable indicator of future results.
This article includes content provided by Standard Life Investments and external fund groups. It does not constitute any financial or other professional advice or recommendations. Content from external fund groups does not represent the views or opinions of Standard Life group.