Although the economic outlook for the UK in 2018 is mixed, we believe the consensus is too pessimistic on growth. The global economy is now firing on all cylinders – which will benefit the international-facing UK market – and we believe the risks to growth, inflation and interest rates are all to the upside, in the UK as well as globally. Consequently, we should now expect to see central banks retreat from the super loose monetary policies that have been in place since the global financial crisis. This will take two forms, increases in interest rates and a run-down in quantitative easing programmes. This will put pressure on asset prices, particularly in fixed income.
For example, in 2017, UK gilt yields started and finished the year at 1.2%, against a general expectation that yields would rise. As the global economy returns to normal, we would expect yields to rise towards 2.0% and corporate credit to outperform government bonds, given the backdrop of a strong economy. However, in absolute terms corporate spreads are now at very low levels, which means that although we are positive, given very low default rates, we are cautiously so. Certain areas of non-financial corporates and banks have seen spreads compress to unattractive levels. In contrast, we are finding that insurers and collateralised bonds still offer some relative value.
Within our global fixed income portfolios, we expect the US dollar and euro will strengthen against sterling in 2018, given the relatively brighter economic outlook. Therefore, we remain overweight in corporate bonds and in Europe in particular. However, we are currently monitoring all markets closely with the view of rotating parts of our global and sterling bond portfolios into more defensive, higher quality assets. This is because, as the European Central Bank begins its tapering this month, parts of the market that did very well last year could come under some pressure, whilst spreads could also compress to unattractive risk/reward levels.
The global economic upswing is also benefiting equity markets, particularly in the US and Europe. Data is showing consistently strong job creation and manufacturing output in the US, whilst European manufacturing is now growing at a faster rate than services. This is positive for job creation amongst other things. From a market perspective, US equites have recently hit record highs and valuations remain expensive. However, earnings-per-share (EPS) growth is forecast at 15% for 2018 and the domestic economic backdrop remains positive, particularly following the recent tax reform.
Although we are relatively positive on the US, Europe remains our favoured overseas equity market given its attractive valuation. In particular, the economic rebound has seen ten year yields slowly lift and consumer and business confidence increase drastically, which should be supportive for equities. Although there are some political risks surrounding the formation of a new German government and the Italian election, we do not believe the bear case will pan out. In China, although growth is slowing, it is better quality and continues to support Asian equities, particularly via the One Belt, One Road (OBOR) initiative. We also believe the ASEAN nations offer a number of attractive opportunities, particularly as they lagged somewhat in 2017.
In the final quarter of last year, Japan was one of the strongest performing markets and this has continued so far in 2018. Valuations are still reasonable, whilst the re-election of Shinzo Abe means that pro-reform policies should continue. Finally, looking at the UK, it is important to note that the market has underperformed the global index over the last three years. However, it ended 2017 strongly despite the Brexit uncertainty. The commodities and energy sectors have been a big driver of performance since 2016 and we expect this to continue, particularly with copper and oil prices performing well.
The UK commercial property market surprised on the upside last year, with a total return of c. 10%. This was largely due to improved investor sentiment in the second half, helping deliver positive rental and capital value growth as the market returned to normal conditions. However, we did witness a divergence in sector performance. Industrial units were by some way the top performer, with demand driven by the unrelenting increase in online shopping and e-commerce. Elsewhere, it was the ‘alternative’ sectors that also outperformed, led by student housing and hotels. However retail continued to be weak, particularly in the regions, whilst the office sector also lagged. However, despite the Brexit uncertainty, overseas buyers continued to make long-term investments into London property, with a focus on prime ‘safe haven’ assets. In addition, the Bank of England’s first rate hike had very little impact, as core real estate continues to offer an attractive spread relative to bonds.
Looking forward, however, we expect returns to be lower in 2018, given the expectation of modest interest rises. Therefore, performance is likely to be driven by income rather than capital appreciation and we expect investor strategies to focus on income-producing areas such as inflation-linked leases and industrials, whilst strategic asset management initiatives will also be crucial. On the slightly weaker retail side, we expect that investors are likely to only focus on prime destination and experience retailing in London, the South East and affluent regional cities.
Past performance is not a guide to future performance. The value of investments may fall as well as rise and investors may not get back the amount invested. Income from investments may fluctuate. Currency fluctuations can also affect performance.
The information contained in this document is provided for use by investment professionals and is not for onward distribution to, or to be relied upon by, retail investors. No guarantee, warranty or representation (express or implied) is given as to the document’s accuracy or completeness. The views expressed in this document are those of the fund manager at the time of publication and should not be taken as advice, a forecast or a recommendation to buy or sell securities. These views are subject to change at any time without notice. This document is issued for information only by Canada Life Investments. This document does not constitute a direct offer to anyone, or a solicitation by anyone, to subscribe for shares or buy units in fund(s). Subscription for shares and buying units in the fund(s) must only be made on the basis of the latest Prospectus and the Key Investor Information Document (KIID) available at www.canadalifeinvestments.com. Some Canada Life Investments funds may invest in property funds that may be illiquid and subject to wide price spreads, both of which can impact the value of the fund. The value of the property is based on the opinion of a valuer and is therefore subjective.
The Canada Life Investments blog page features images licensed from Getty Images International. These images shall not be downloaded, republished, retransmitted, reproduced or otherwise used in any way. Aside from the above, and unless otherwise stated, Canada Life retains copyright in and/or has a right to use all contents of this website (including text and graphics) and such contents shall not be copied, distributed, extracted or modified without the express prior written consent of Canada Life unless for private, non-commercial use.
CLI01077 Expiry 15 January 2019