The environment facing investors today can best be described as challenging. While recent equity market performance could suggest all is rosy in the world, there are clearly a number of dark clouds on the horizon, both in the UK and globally.
In the UK, Brexit continues to dominate sentiment as the government seeks to balance the requirement to reveal its position on key issues, without giving away its hand to European negotiators. Despite this large overhang, the UK economy continues to perform well, posting robust growth numbers for 2016. We anticipate the UK delivering growth of close to 2% in 2017, well above consensus forecasts.
However, arguably even more impressive than the UK’s recent performance has been the economic recovery in Continental Europe. Europe is still viewed pessimistically by many participants in the market, but beyond the noise the underlying fundamentals seem to be improving on a daily basis. Europe has now posted 14 consecutive quarters of growth, with unemployment falling back into single digits and job creation hitting a nine-year high. Business sentiment is also at its highest point for six years.
Why are investors still undoubtedly cynical towards Europe? Similar to many other occasions in recent years, the answer can possibly be found in politics. Europe faces key elections in the coming months – with votes taking place in France, the Netherlands and Germany. With the rise of populist candidates across Europe, together with the recent experience with the Brexit and US presidential votes, the outcome is far from certain. There also remains question marks surrounding the health of the Italian banking system, as well as renewed concerns about the economic stability of Greece. While the overall European economy continues to pick up, it is not difficult to understand why Europe remains one of the today’s most unloved geographies in which to invest. It also helps to explain why the perceived safe haven of short-dated German bund remains in strong demand, hitting record low yields in recent weeks.
Also, another major issue investors are confronted with today is the impact of Donald Trump as President of the United States. While some of his planned policies are seen as growth friendly, there are also many risks attached to his current rhetoric – particularly potential trade hostilities with China and risks around the deficit should large scale spending be undertaken. There is also the potential impact on markets of a ‘rogue tweet’ from the US President – which may be one of the more unusual risks I have witnessed in over 30 years investing in financial markets!
So, what does this all mean for investors? As always, diversification is vital. Diversification across sectors and asset classes can help to protect investor downside during periods of heightened volatility.
In the UK, the outlook for equity markets remains constructive. In particular, the weakness in sterling following the Brexit vote last year continues to boost the competitiveness of the UK’s large exporters, even with the uncertainty surrounding the approaching exit from the EU. However, the recent tick-up in inflation may provide challenges for domestically-focused areas of the market, such as retail. Europe’s recovery in theory should boost equity markets across the region, but there is plenty of scope for negative surprises, especially in political spheres.
We would expect a continued gentle tick up in bond yields as we move through the year, meaning it is prudent for our fixed income allocation to be at a slightly shorter duration and term than the benchmark. Short-duration positions can help investors mitigate the potential impact of higher rates in the future. We also have a preference for credit over government bonds, with corporate bonds remaining well supported by the actions of both the Bank of England (BoE) and the European Central Bank (ECB).
As for UK real estate, we remain cautiously optimistic towards the asset class. While capital values may not see any major increase this year, property will continue to deliver steady income generation.
The value of investments may fall as well as rise and investors may not get back the amount invested.
This information is for professional advisers only. 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 are subject to change at any time without notice. The contents of this article are not intended as investment advice.
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CLI00671 Expiry on 28/02/2018