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2017 – taking stock

15 December 2017

As we look forward to the Christmas holidays and the new year ahead, we also tend to look back at what the year past brought us. In particular, in our profession, we look back at how the year actually unfolded relative to the expectations and forecasts we published a year ago. Surprisingly positive is likely to be the reaction of holders of globally diversified capital market investments, like the various portfolio types we manage for UK savers and investors. As our generic asset class returns table above shows, up to the end of November, stock market investors enjoyed another year of very reasonable returns. Only low risk fixed interest bond investments and commodity investors not a not-quite-as-stellar year; yields simply couldn’t fall any lower to provide yet another boost to bond values. December has not changed the picture materially for the year, with markets trading more sideways than decisively up or down.

Looking back at what we wrote a year ago, I am pleased that our outlook and anticipated central scenario was very close to how 2017 developed. I am particularly relieved that the risks to our central scenario which we had also listed did not materialise. I’m especially pleased that our hope that the already strong and globally synchronised upward economic momentum would carry on and perhaps prevent president Trump from feeling obliged to push through some of his more obscure and potentially damaging election promises has played out.

The prospect of less regulation and lower taxes helped to lift sentiment and thereby activity levels of the smaller business sector in the US, while the checks and balances of the US political system prevented the Trump administration from passing into law any really damaging ‘America First’ policy initiatives.

The rise of populism also seemed to have passed its peak, as electorates across Europe observed Trump’s political ruckus and appeared to have realised the potentially severe consequences protest voting can have.

2017 turned out to be a far less turbulent year, and it proved that 2016 had indeed marked a turning point in the aftermath of the global financial crisis and recession of 2008/2009. Fiscal austerity did fall out of fashion in most countries and business confidence slowly returned. With it, business investment also came back, which allowed the global economy gradually turning towards a development path more in line with historical observations and averages.

That was good news for corporate earnings, which expanded rapidly as a result and supported higher than expected valuation levels for stock market quoted companies. This led to much better than the just ‘decent’ returns we had expected, with global equity investors enjoying yet another year of double digit returns.

This then leads to the dominating investor concern of 2017: have stock markets risen too far and therefore become susceptible to a painful correction? Since the spring, this fear has dominated investor meetings and discussions. All the while stock markets kept grinding higher, supported by continued corporate earnings growth and an ever brighter macroeconomic picture developing around the world.

Sadly, the UK marked the exception to the strong economic trend, with the persistent uncertainty over the nation’s trading position post Brexit holding back business investment. Increases in the cost of living as a consequence of the £-sterling weakness additionally put additional pressure on consumers, who slowed their demand as nominal wage rises failed to compensate the price rises. Towards the end of the year, however, we observed that global and particularly Eurozone growth is finally trickling down to the UK economy. And, together with the Brexit negotiation breakthrough, light at the end of the tunnel seems to be in sight.

We will close the year next week with our more comprehensive investor outlook for 2018, but as an ‘outlook to the outlook’ let me say this much: the theme for 2018 will likely become readjustment pains to an ‘old normal’ environment. What I mean by this is that all those capital market aspects that over the past years have moved away from their long-term averages – as a consequence of the extraordinary monetary policy measures that had to be deployed to get the economy back on track – will begin to drift back.

This means rising yields will result in even lower returns of low risk fixed interest bonds than 2017, and all assets whose valuations were particularly boosted by low interest rates and bond yields are likely to come under pressure. This makes us concerned about commercial and residential property values, especially in those regions where they have significantly surpassed the pre-2008 levels. Canada and Australia, but also the UK, are unfortunately such regions.

For now, we are pleased that capital markets have enabled us to generate another set of decent-to-very-decent annual investment returns. We turn to tackling the challenges of 2018 in the knowledge that the global economic backdrop is resting on much more solid foundations than 12 months ago. However, after another very strong year for both the global economy and capital markets, we also acknowledge that further improvement in the rate of improvement may from here be more limited. This, together with the potential headwinds discussed above, makes it prudent to assume that, while the global economy is most likely to continue to expand and normalise during 2018, capital markets are likely to become turbulent once more and produce more pedestrian results, while the ‘hangover’ from the heady days of QE-induced easy money requires time to wear off.