Risk rose in 2017—via North Korea’s ongoing saber rattling in the form of ballistic missile tests; the re-emergence of global populism which this past year included Donald Trump’s first year as president of the US; the UK’s continuing, muddled Brexit negotiations; the ascent of Catalan separatism and recent Euroskeptic election victories such as Sebastian Kurz’s People’s Party in Austria, not to mention the weak outlook for a variety of nationalist-leaning parties in South and Central America—but global markets remained exuberant, with US markets at the forefront, though shares in South Korea (up 21.76% YTD), Brazil (+25.72% YTD) and Hong Kong (+35.99%) outpaced US gains (18.7% for the S&P). The best performing index this year however was Vietnam's Hanoi 30, up a whopping 54.4% .
At the beginning of 2017 many wondered if the Dow Jones Industrial Average, which started the year at 19872.86, would hit 20K. It ended the year at 24,719.22—24% higher on the year and 22% above that 20K ‘fantasy.’ It hit more than 70 new record highs in 2017, the most record closes for a year ever, surpassing the previous record of 69, made in 1995.
The S&P 500 wasn’t exactly a laggard either: it began 2017 at 2251.57 and closed at 2673.61, up 18.7%. The NASDAQ Composite also outperformed expectations, gaining 28.2% over the course of the year, propelled higher by tech sector shares that rose 33% on the year (using iShares US Technology (NYSE:IYW) as our benchmark).
Oil appears to finally have recovered from its swoon after the 2016 slump, but the dollar continues to look unsteady. Volatility remains practically non-existent, but cryptocurrencies have been on an eye-popping tear, barreling past other assets this year in terms of percentage gains: Bitcoin hurtled higher by 1309% for 2017, having started the year at $999; Ethereum rocketed from $8.17 to $736.50, up 9028%, and Ripple rallied from $0.00652 to $1.93, or 29,501%.
On a quieter note, the Fed delivered on their three-rate-hike promise this year, with another three forecast for 2018. Though the European Central Bank (ECB) has confirmed that it is cutting monthly asset purchases they remain cautious about raising rates. As for the Bank of England (BoE), along with general monetary policy decisions, they also must contend with what remains a great unknown—how will Brexit negotiations play out for the UK?
Many claim they’re happy to see 2017 in the rearview mirror, but from a markets perspective it was indeed a very good year. Will 2018 be as good (or perhaps better) for investors? We asked 5 of our most popular contributors how they see markets performing as 2018 begins.
David Bassanese: Don't Get Defensive
My main recommendation is to remains overweight risk assets. With global corporate earnings still improving, equity valuations still not stretched given low bond yields, and a continued absence of inflationary pressure - it is not yet the time to be defensive. The likely imminent approval of US tax cuts should further buoy sentiment.
While bond yields are likely to rise over the coming year, low inflation will keep the lift only modest – and not enough to derail the global equity bull market.
Given Australia’s more muted earnings outlook, favoured growth exposures remains skewed toward international equities, particularly the US tech sector, Japanese equities and global banks.
Within Australia, the challenges faced by our large-cap financial and resource companies suggest better growth opportunities may be available outside of the mega-cap space.
Ric Spooner: This Year Is Different
The end of the year is traditionally a time for investors to reflect on the year that has been and to set investment plans for the year that is to come. Reviewing the opinions of my investment industry colleagues, I am as usual, struck by two things. First how sensible the consensus view appears. Second, how unlikely it is to be correct. Unknowns have a habit of emerging to upset the consensus outlook.
What is different about the standard outlook for 2018 is that the investors are becoming less concerned about risk. For stock market investors, particularly in US markets, this means that the impact of any unexpected negative developments could be significant. Valuations are high and downside risks are more substantial than at the beginning of this year.
For me, 2018 looks like a year to reduce allocations to stocks, especially in the US. Selling into strength will fly in the face of what others are doing and require some independence of thought. It will also create some ammunition to take advantage of the unexpected.
Chris Weston: A Tale Of Two Halves
The central macro-thematic remains that we should see more of the same and a continuation of the dominate themes seen throughout much of 2017, that is, at least through Q1 and Q2 ‘18. Global growth should remain upbeat, with US, Europe and China pushing the global growth story towards 4%, so as an asset class commodities should continue to perform well, therefore, being overweight materials and industrials should generate alpha.
At the same time, corporate earnings should keep equity markets supported, although on a select basis, given correlations between developed market equity indices are at a 20-year low. Highly predictable G3 central bank policy won’t change, with their dominant volatility suppressing weapon, forward guidance, keeping confidence levels among market participants high. Inflation, at least in the first half of 2018 will not be an issue and while central banks will gradually normailse policy, financial conditions shouldn’t tighten to any great extent.
This ‘Goldilocks’ scenario and inspiring mix of macro-factors should keep the insatiable demand for yield in play and result in an even flatter Treasury yield curve and inspire funds to sell volatility on any sudden spikes. With low implied volatility we get the secondary effect of hedge funds and asset managers holding near record low portfolio weightings in cash and maintaining elevated exposures to equities and credit. I mention price pressures in developed markets could be a second half story and while it seems highly unlikely we see 1970’s, early 1980’s type price pressures. At least relative to sanguine market pricing of inflation expectations, if these expectations do eventually rise, this may cause increased anxiety, as financial conditions tighten, driven on the belief of a more aggressive central bank policy stance. This could cause a sizeable short volatility position to be partially unwound, which in-turn would promote a portfolio shift towards higher cash levels.
So, at this stage in the cycle, it seems that 2018 could be defined as tale of two halves, where credit, equities and EM assets continue to work, while this script potentially changes in the second half and outperformance comes from exposure to the yen, gold and a rotation out of materials and into utilities and staples. The two focal points though above all though, that will dictate the investment landscape, will be moves in inflation expectations and implied volatility.
Wilbur Li: A Nervous Rally Ahead
2018 will be a big year for all investors. The optimists in the room certainly have reasons to be bullish: we are in an era of synchronised global growth, company profits are at record levels and things are looking rosy. The bears will remind us that investors have taken on too much risk and that we are overdue for a crash.
With these opposing views, who should we believe? My guess is that things are probably somewhere in between and the rallies in major global equity indices are likely to continue for some time. However, the more money everyone is making, the more nervous I get. With this in mind, here are two things I would be doing:
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As the market keeps rallying and everyone gets more excited, I would think about taking some risk off the table.
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Ask yourself the question, “what would I do if the market lost 50% tomorrow?”. Are you still comfortable with your holdings and do you have a contingency plan?
Jonathan Rochford: Investors Should Loiter Around The Lifeboats
Imagine it’s 1912 and you find yourself on the Titanic’s maiden voyage. You know that the ship is going to sink but you’re sketchy on when it’s going to happen. What should you do? This scenario is similar to the current predicament for investors where almost all asset classes are expensive when using standard valuation techniques. The answer for both situations is the same; you should spend your time loitering around the lifeboats.
The former CEO of Citigroup’s infamous comment that “as long as the music is playing you’ve got to get up and dance” highlights a major behavioural impediment to solid long term returns. The temptation is to ignore the risk right in front of you and buy investments that hold out the prospect of a quick win. Institutional fund managers are measured quarterly or monthly and can feel pressure to constantly outperform, especially if they charge substantial fees. Individual investors can lose focus when their friends and neighbours brag about how much they have made on the latest fad investment. We all struggle to keep the disciple and focus needed in these exuberant times.
Many investors spend their time speculating what will be the trigger that starts the next downturn. The theory is that if you pick the trigger you can sell out prior to others, capturing all of the upside and none of the downside. In practice, the trigger for market peaks is rarely knowable in advance, most times the trigger event is a narrative created after the event to fit the facts. Rather than focussing on potential triggers, investors should focus on the risk/return characteristics of what’s in their portfolios. Stock prices and credit securities follow earnings and cashflows over the medium term. Time spent on detailed earnings and cashflow analysis (which increasingly few do) will be far more fruitful than time spent analysing the widely known economic, political and geopolitical risks.
In my home ground of credit, loitering around the lifeboats means staying short in credit duration and staying senior in the capital structure. Fortunately, making these shifts is often easy to execute when markets are exuberant as the increase in yield for taking extra risk is minimal. Going against the trend will cost a little in the yield achieved now, but that gap can be made up ten times over when the next downturn occurs. If correctly implemented, in the next downturn an investor will have cash from maturing assets to redeploy into bargain credits rather than a portfolio of distressed debt with substantial mark to market losses.
The innate human desire to want to keep up with the Joneses is an investor’s worst enemy in bullish markets. Ultra-low cash rates and quantitative easing have helped markets to continue to post gains beyond what company earnings and GDP growth support. Investors are increasingly all-in, having become numb to risk in a time of record low volatility.
By implementing a loitering around the lifeboats strategy, investors will likely miss out on some late stage gains. However, the potential pay-off is far larger than the missed gains if the overdue correction occurs. The more investors believe that markets are unsinkable, like the Titanic, the more likely it is that an iceberg is dead ahead.