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Don’t expect 2017’s straight line equity performance in 2018

28 December 2017

Investors should be prepared for a switch in mood across financial markets in 2018, with the gains achieved this year by equities unlikely to be repeated, according to Stephen Jones, Kames Capital’s chief investment officer (CIO). But investors should keep their faith in equities.

Headwinds from rising interest rates, geopolitical events, and even the threat of nuclear war have failed to deter markets in 2017. Every risk has been shrugged off as cheap money and unexpectedly strong growth, not to mention stable inflation, have powered equities higher amid improvements in corporate profitability.

However, next year could well be very different, Kames’ CIO, with a further surprise to the upside from corporate profits unlikely.

“Looking ahead to 2018, such a surprise is unlikely; forecasts for growth and profits are now much more realistic,” he says.

“It is probably naïve to anticipate that markets will go up in a similar ‘straight line’ as they have this year.”

Nonetheless, Jones says the environment can still be conducive for further equity market gains next year.

“Ironically, the return to volatility can be comforting; investors will be reassured that gains are being ‘hard won’,” he says.

“If volatility does return then it will likely be driven by the behaviour of bond markets; another year of economic good news will embolden those calling, yet again, for higher long-term interest rates. But unless inflation rises materially and sustainably – which I doubt – then bond yields seem likely to remain at levels which offer support to equity markets (rather than emerge as a competitive alternative).”

Jones says equities – even at these lofty levels – continue to offer investors an attractive risk/reward trade off.

“Investors should not lose faith in equities next year,” he says. “Despite the rise in market levels this year, little has changed. The economic outlook for Europe and Japan looks solid, China seems set for solid 6+% growth and the US is ending the year strongly.”

Only the UK looks weak, says Jones, but ‘weak’ may well be in the price. “Companies should be able to prosper in this environment and I see nothing to suggest that investors have built up strong equity weightings. Beyond the occasional ‘tech’ stock there is no evidence of complacency, and overall 2018 looks capable of being as rewarding for investors as this year, although it will probably be more ‘exciting’.”

Jones adds the asset class to continue to avoid remains cash. “Holding on to equity positions seems wise and I still struggle to see a role for cash other than for the occasional market spasm which are, by their nature, almost impossible to predict.

“The penalty, should you get caught in cash, remains high relative to the yields available in equities and, dare I say, in bonds.”

 

 

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