2017 could be a particularly challenging year for investors, professional money managers have warned, given that monetary policy is warping asset prices and there are a number of political risks on the horizon.
The FTSE 100 rallied following the shock EU referendum result, which has led to concern from many industry commentators given the economic uncertainty likely to take hold once Article 50 is triggered.
Performance of index since referendum
Source: FE Analytics
Given this unusual market behaviour combined with ultra-low interest rates and the re-introduction of quantitative easing, many investors believe that a cautious approach is needed when investing in the UK at the moment.
Alan Custis, who runs the four crown-rated Lazard UK Omega fund, believes that UK economic data and positive investor sentiment could have been skewed by a series of unusual and short-term factors.
As such, he says recent events have made looking forwards more difficult than ever for investors and warns that 2017 could bring them back to Earth with a bump.
“I think the stock market is higher now than it would have been had we voted to remain,” he said.
“I think the ‘remain’ vote was obviously what people expected and I think we would have then continued on the austerity-style budgetary process that George Osborne had outlined in his bid to remove the deficit by 2020, that was his mantra.”
“I think that all changed. We had, primarily from a UK stock market standpoint, sterling fall precipitously and, as of today, we’re back down to the levels we saw immediately in the aftermath [of the referendum].”
“From a FTSE 100 standpoint, that’s been a huge shot in the arm in terms of earnings forecasts and the fact that a lot of dividends are declared in euros or dollars in the index has helped as well, so the dividend growth which had been expected to be pretty lacklustre has now become positive because of the currency.”
“We’ve had quite a tailwind to earnings and dividends because of the currency and so I think that’s been a big driver.”
The manager points out that the recent cut in interest rates, which saw them halved to 0.25 per cent last month, would not have happened had the UK voted to ‘remain’ and says that this has also impacted both economic data and market sentiment.
He also says the Bank of England’s introduction of quantitative easing has led to the economy to seem “surprisingly robust” given the uncertainty surrounding what will happen after we leave the EU.
“I think it’s more difficult looking forwards than it has been at any time. July and August are not big months from a corporate standpoint and we had the Olympics, the Euros and the weather was okay. My slight concern is that it’s been a phony economic stability and that the ‘real deal’ is going to be when we trigger Article 50 and that’s when the hard yard effectively starts,” he explained.
“What we want to do is not get too carried away with the euphoria of ‘look how good the UK is, we’ve gone through the vote and it’s all happy days’. I am concerned it gets a lot tougher going forwards – whether its conversations around passporting for financial services for instance, or how long it’s potentially going to take to negotiate trade.”
“I think that’s when reality dawns. In the intervening period we have the Autumn statement from Philip Hammond, which has clearly been showcased as being a fiscal stimulus. Again, I’m not sure we clearly would have had that Autumn statement had George Osborne been in charge.”
“There are lots of things that have changed that, short term, mean the market is in a better frame of mind but we need to be careful not to get carried away because things could turn down in 2017.”
Neil Shillito, co-manager of the Downing Diversified Global Managers fund, agrees that investors should not be lulled into a false sense of security as we head through the rest of the year.
He says that the implementation of ultra-loose monetary policy should not be greeted with a sense of relief by investors as it has warped market valuations while doing nothing for the real economy.
“The economic ‘stability’ is phony and built on foundations of sand. There are many and varied reasons for this but I would point to QE as being the main culprit,” he argued.
“QE has done nothing for the real economy and has merely inflated asset prices to unsustainable levels. Once the loose money has started to pile into classic cars you know the party is over.”
“Catalysts and tipping points nearly always come from left field. Default rates on high yield debt are rising and we have equity income yields that are wholly unrealistic and leveraged, so we’re in for a kicking but I don’t know when or what it will be that triggers it.”
Performance of sector over 5yrs
Source: FE Analytics
“Investors are probably sleepwalking into 2017.”
Ben Willis, head of research at Whitechurch Securities, also says that UK economic stability is under pressure as a result of GDP forecasts being downgraded, which is why the Bank of England cut rates and restarted QE in the first place.
However, he says that the strong performance of markets has taken the team by surprise and suggests that investors have “shrugged off” any immediate concerns regarding the Brexit vote.
“Considering we still do not know what the post-Brexit landscape will actually look like does pose some concerns and with short-term market sentiment being driven by the macro and politics, then the actual process of leaving the EU, whenever it is triggered, will have an impact,” he warned.
“2017 will be challenging but not just because of Brexit, as the path of US interest rates, the strength of the US dollar and China’s economy will continue to weigh on investors. All of these factors will continue to create moments of volatility next year.”
“However, as we have seen time and time again, they tend to have a short-term impact. The basic investment tenets come to mind – make sure you are diversified and invest for the long term.”
Informed Choice’s Martin Bamford points out that there are always reasons for investors to be fearful.
He says his clients are expressing concerns that a perfect storm could brew as a result of a Trump election, short-term uncertainty caused by the triggering of Article 50, further debt problems in Europe and geopolitical conflicts involving ISIS, China or Japan.
As such, he agrees with Willis that diversification and limiting exposure to any one investment type is the best way for investors to protect their portfolios.
“I think to some extent all global markets are artificially inflated by a long period of monetary easing,” he said.
“Central banks have been manipulating bond and equity markets since the global financial crisis, which surely can’t be sustainable long term. Something investors can’t know at this stage is when this phony performance will begin to unwind and whether it will be a hard or soft landing.”
“Of course not all of the UK investment market performance is the result of this central bank interference. The UK economy has a lot going for it, so it’s important we are not too negative about the outlook, especially in innovative areas such as fintech and science based research.”
Patrick Connolly, head of communications at Chase de Vere, says that after a strong run and given the level of uncertainty at the moment, there is every likelihood that there will be a fall in share prices.
That said, he reasons that this could happen at any given point as nobody can time the market and points out that it might not happen at all next year.
“There isn’t an immediate correlation between stock market performance and economic growth and markets have risen on the back of surprisingly positive investor sentiment since the EU referendum vote,” he said.
“However, at some point corporate earnings will have to improve to justify stock market valuations. Positive sentiment alone won’t keep pushing and holding markets up indefinitely.”
“If we don’t see an improvement in earnings we can expect to see markets falling at some point.”