Our Opinion: 2016
What does 2017 have in store?
The fall in sterling turned 2016 from a difficult year for UK-based investors into a good one, but with sterling more likely to appreciate in 2017 than weaken further, that tailwind is no longer blowing. A good performance from equities in 2017 will require either earnings growth, or stocks to trade on a higher valuation. Neither is a given.
Investment analysts are forecasting double-digit earnings growth for next year, but those forecasts are usually relentlessly downgraded over the year. A re-rating of equities onto higher valuations would normally require either an excess of investor enthusiasm, which looks unlikely, or lower bond yields.
Instead, the predictable crash in bond markets looks likely to continue. Bond investors have, at last, lost confidence in central bankers and woken up to the reality that ultra-low bond yields are encouraging a borrow-and-spend binge by governments. Higher bond yields should give politicians second thoughts, but this is unlikely until central banks have responded with higher interest rates and, probably, an economic slowdown has been set in motion.
But not all is gloom. Stocks have held up well in the face of rising bond yields and should move ahead when yields flatten out in 2017. Earnings will be helped by a rebound in the energy sector, and there are bright spots elsewhere. Patient investors who are prepared to take a bit of risk should be well rewarded.
After four dismal years, the performance of emerging markets turned around in 2016, although the recovery suffered a setback when Trump’s election boosted the dollar. But the dollar is far from the sole determinant of the fortunes of emerging markets. Undervalued currencies, higher resource prices, more market-orientated governments, sounder finances and steady growth are all supportive, added to which firms are prospering and reasonably valued.
The threat to the healthcare sector that would have been posed by Hillary Clinton as US president has disappeared – though the consequences for the higher-quality, innovation-led firms were always exaggerated. The long-term growth outlook is intact and the valuations of portfolio companies are very reasonable.
The performance of medium-sized and smaller companies in the UK has been disappointing lately – they have failed to outperform the FTSE 100 this year. The FTSE generates a larger share of profits directly from overseas than mid- sized and smaller companies, and so has benefited more from sterling’s weakness. However, the long-term trend for smaller companies to outperform larger ones, which also applies internationally, looks set to continue
The safest prediction for 2017 is that patient investment in funds run by managers focused on long-term stock selection will do far better than those reacting to changing political events.
Trump is in some ways the least of our worries. Next year elections are happening across the euro-zone and any of them could be the straw that breaks the camel’s back. A messy break-up of the euro would put a dent in virtually all investment strategies. There are good reasons to believe the euro will survive 2017 and, possibly surprise on the upside. But given its built-in contradictions, it’s only a matter of time before it breaks up.
That may be a theme for this year. The Euro was introduced in 1999, when faith in globalisation was at its peak. The global call for a new type of politics inevitably means a fundamental re-think of economic direction too. It’s going to be an exciting year and certainly one where high quality advice and management has never been so important.
19th December 2016