Bull or bear? The big issues fund managers face in 2018
Markets appear vulnerable to temporary sell-offs as risks bubble over
After a stellar year for markets in 2017, the world’s largest investors are grappling with a big question: can 2018 deliver the same high returns?
Global stocks generated their best annual performance since the post-crisis recovery on the back of the so-called Goldilocks combination of strong growth and low inflation.
Asset managers would like those “just right” conditions to continue — but some of them are nervous amid fears about the sustainability of high valuations, coupled with inflation and rising interest rates.
Richard Turnill, global chief investment strategist at BlackRock, said: “[Last year] was a near-perfect one for risk assets. The road ahead looks more challenging.”
The consensus is that the issues fund managers are likely to face in 2018 will include a possible change in the investment cycle together with concerns about global growth, rising valuations in the US, inflation and Chinese debt.
Goodbye Goldilocks?
One of the biggest questions is whether we are nearing the end of the post-financial crisis investment cycle. Some investors worry about growth stalling.
Michelle Seitz, chief executive of Russell Investments, the $290bn fund house, said: “After eight years of growth, many of the hallmarks of an ageing business cycle are starting to flash amber.”
But Keith Wade, chief economist at Schroders, said the UK’s second-largest asset manager had upgraded its global growth forecast for 2018 to 3.3 per cent from a previous estimate of 3 per cent. “If correct, this would make 2018 the strongest year for global growth since 2011,” he added.
Mr Turnill believes there will be “stable growth with room to run” in 2018: “We believe the remaining time to this cycle’s peak is likely years. We do see less scope for upside growth surprises as consensus expectations have mostly caught up with our GPS for G7 economies over the past year.”
Running with bulls
Throughout 2017, US President Donald Trump was quick to tweet how US equity markets were at all-time highs. Global stock markets have also done well, with the FTSE All-World index returning almost 22 per cent.
Many investors have benefited from the bull market but question whether sky high valuations can continue.
Stephen Jones, chief investment officer at Kames Capital, said investors should be prepared for a switch in mood. “It is probably naive to anticipate that markets will go up in a straight line as they have last year.”
Ms Seitz said: “Our central view is that equity markets can push higher before facing headwinds later in 2018 as markets factor in rising risks of a 2019 recession. Running with the bulls can be dangerous. It’s easy to get swept up in the elation of the crowd and underestimate the risks.”
Others highlight the bright spots. “Equities may be expensive, particularly in the US, but as long as corporate earnings are going up they’ve still got a way to run,” said Luca Paolini, chief strategist at Pictet Asset Management, the Swiss fund house.
“European, Japanese and [emerging market] equities have even better prospects. The sun is shining especially brightly for eurozone equities.”
Matteo Germano, head of multi asset at Amundi, Europe’s largest-listed fund house, does not foresee any “imminent risks driving a deep market sell-off”.
“We believe [investors] should use the time . . . to recalibrate risks in their portfolios during the year to a more defensive positioning, with a strong focus on quality,” he said.
Rate rises and the unwinding of quantitative easing
Last year marked a change for the long-running policy of central banks pumping money into economies through quantitative easing.
The Federal Reserve, which is slowly raising interest rates, announced that it would gradually begin selling some of its gigantic bond portfolio. Other central banks have also begun increasing interest rates, including the Bank of Canada.
Many investors believe that any further moves to interest rates or quantitative easing programmes will be well signalled by central banks, but some worry the pace of change will be faster than anticipated.
James Elliot, multi-asset chief investment officer at JPMorgan Asset Management, said: “We’ll be closely watching the US rising interest rate environment in 2018 and we think the Fed will move more rapidly than the market currently expects and rates will rise as a consequence.”
Edouard Carmignac, the investor who founded Carmignac, the French investment house, believes investors will “need to prepare well in advance for the upcoming change of liquidity regime”. “Caution and selectivity will be the name of the game in the credit space,” he said.
China worries
Many of the world’s largest investors will be paying close attention to China in 2018, particularly around how the government will maintain growth while dealing with a heavy debt burden.
Johanna Kyrklund, global head of multi-asset investments at Schroders, sees the US dollar playing a big role for China over the next year, with a weak greenback critical for the economy.
“Our expectation is that the US dollar is likely to remain weak as the rest of the world is catching up with US growth. If we are wrong and the US dollar strengthens, however, this would put pressure on Chinese growth and would tighten liquidity,” she said.
John Vail, chief global strategist at Nikko Asset Management, expects China to “grow a bit slower than expected due to the deleveraging, anti-pollution and other campaigns of restraint following President Xi’s consolidation of power”.
But JPMorgan’s Mr Elliot sounded an upbeat note. “GDP growth has surprised positively over the course of 2017 and progress is being made on rebalancing, which suggests growth will be higher quality and more sustainable,” he said.
Inflation
Inflation was one of the biggest issues on investors’ minds in 2017. A poll by Bank of America Merrill Lynch in late 2016 found that 84 per cent of fund managers expected a rise in global inflation.
The concerns, however, were largely unmerited, with inflation remaining low in most global economies.
But Larry Hatheway, chief economist at GAM, the Swiss asset manager, expects a key development in 2018 will be the “potential advent of accelerating inflation”.
“It matters most [of all investment issues] because it is almost entirely unanticipated by markets, yet seems likely from the perspective of macroeconomic conditions,” he said.
“It is also of great significance because unanticipated inflation will lead to major setbacks in both bond and stock markets, with significant aftershocks in almost all asset classes.”
Samy Chaar, chief economist at Lombard Odier, argues that if inflation does creep up during the coming quarters, “financial market volatility should make a comeback and developed market government bonds — an asset class that we have long strongly underweighted — come under further pressure”.
Patrick Moonen, principal strategist for multi asset at NN Investment Partners, the Dutch asset manager, warned that an unexpected surge in inflation would have a negative impact on equity markets.
“If this leads to an economic slowdown, the equities bull market would be in serious trouble due to the combined headwind of lower valuations and lower earnings growth,” he said.
What does this mean for investors?
Mr Turnill believes markets are likely to be more vulnerable to temporary sell-offs this year, sparked by the bubbling over of risks.
“We believe investors will still be compensated for taking risk in 2018 — but receive lower rewards,” he said.
