2017 was the year of the bull – 2018 may not be
January is an important month in the investment calendar – this year more than most. After a bullish 2017, where most risk asset classes made consistent, if not impressive gains, many feared this long bull run would come to a shuddering halt. However, a month in to 2018 and with a round of solid economic data coming out, the mood of market participants has become increasingly optimistic.
But should they be? It is undeniable that after the tumult of 2016, 2017 saw markets perform exceptionally well, despite a tense geopolitical backdrop. Take major indices as an example. Over the course of the 2017 calendar year the FTSE100 was up 7.6%, the FTSE250 was up 14.65%, the Dow Jones closed 25% higher and the NASDAQ climbed 28%.
2018, however, will be more difficult. The aftermath of the financial crisis and the monetary policies pursued by central banks in the form of quantitative easing has led to stretched valuations across the board. The impact of an increased money supply has even trickled down in to the valuations of newer, less tangible asset classes like cryptocurrencies.
In 2017, the S&P saw 12% earnings growth against a backdrop of a 20% price rise. In other words, share prices are rising faster than earnings and this year there are similar expectations and extrapolations in terms of earnings growth across most major markets.
However, with high expectations and high valuations, danger is never far away. Global economic growth will generate some momentum, alongside the tax reforms in the US. With most major economies growing simultaneously, there may well be an accretive effect which feeds through in to global GDP growth. However, we are at a late point in investment market and economic cycles respectively.
At London & Capital we are advising clients to proceed with caution and to remember the importance of protecting capital especially when the market environment is driven by greed.
Part of the reason for caution is the prospect of further monetary policy tightening. At the very least there will be a series of interest rate hikes in the US with the prospects of a reduction in monetary stimulus in Europe and even in Japan.
However, it is the UK that represents the best example of the pitfalls from the interest rate cycle. The Bank of England Monetary Policy Committee’s recent hawkish rhetoric may potentially lead to a trigger for a downturn from the interest rate cycle. The uncertainty around Brexit and the stretched British consumer means that rate hikes in the UK would be a blunt instrument in dealing with temporary cost inflation from a currency devaluation which has now passed.
Additionally, with the UK consumer having taken on significant levels of personal debt since the financial crisis, interest rate rises at this stage may hamper the spending of Britons further still and create a bust in consumption from a classic rate cycle trigger.
It is on the subject of debt that we need to talk about another significant economic player: China.
China’s debt risk is considerable. Its debt to GDP ratio has surpassed 200% as the Chinese economy has pivoted from being production and export-led, to being consumption based. The 200% threshold represents a watershed moment. This is the point at which in the past countries from Japan, Spain and the Tiger economies of the Far East in the late 90s reached before they slowed significantly and endured economic discomfort.
China will likely be unable to continue growing at the 6% clip it has in the recent past given this debt level. As the world’s second largest economy, even a relatively small drop in the rate of growth could have significant consequences – not just for manufacturers, industrials and those who have seen China as the world’s workshop. It will also have an impact on retailers keen to target an increasingly wealthy Chinese consumer. Commodity prices could also be affected.
China’s demographics are also changing quickly. With the effects of the one-child policy promoted by the Chinese Communist Party in the latter part of the 20th Century becoming more apparent, China’s population is peaking, meaning a supersize generation of retirees may need to be supported by a smaller, younger cohort. This again could constrain disposable income with all the consequences that brings to business. As such, it may well be that the Middle Kingdom grows old before it grows rich.
There are plenty of warning signs which should make investors cautious about the investment landscape in 2018. This year, the old investment adage that past performance is not a reliable indicator of future results has never been truer.
Roger Jones is Head of Equities at London & Capital. London & Capital is an independent wealth and asset manager. This article has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for investment advice. Always seek appropriate professional advice.