Fiscal policy and the increasing significance of geopolitical movements mean Japan, healthcare and value stocks offer the brightest prospects for next year, according to a selection of global equity specialists.
This year has certainly given investors food for thought, given the EU referendum, the US election and the rising profile of populist parties across the globe.
Meanwhile, experimental monetary policy ramped up the hunt for yield at the start of the year, with dividend-paying stalwart stocks rising rapidly in price.
This has turned on its head in recent months though, as murmurings of fiscal policy across the globe have coerced investors into buying value plays again.
Performance of indices in 2016
Source: FE Analytics
Given the swift turnaround in market behaviour throughout the course of 2016, what should global equity investors be looking out for in the new year?
In terms of region, some industry professionals believe Japan could offer up some good opportunities, given attractive valuations and improving economic fundamentals.
Michael Stanes, manager of the CF Heartwood Balanced Multi Asset fund, says Japanese equities are attractively valued relative to other developed markets and should benefit from an improving corporate earnings backdrop.
“Japan is an unloved equity market based on a lacklustre macro environment and disappointing policy outcomes, whether through ‘Abenomics’ or the diminishing impact of Bank of Japan stimulus,” he explained.
“Our reasons for investing, though, are less beholden to policy expectations, but focused on the micro story, where corporate governance developments are driving efforts to improve shareholder value.
“We also believe there are interesting opportunities to be found in the ‘New Japan’, which includes domestically-focused sectors positioned to benefit from ageing demographics (healthcare and consumer discretionary) and digital advancements.”
Richard Turnill, global chief investment strategist at BlackRock Investment Institute, sees developed markets moving higher in 2017 and particularly likes Japanese equities due to the weaker yen, improving global growth and potential earnings upgrades.
He also expects US markets to do well and is positive on the prospects for emerging markets, despite seeing potential trade tensions as a risk.
“We see earnings growth and further rotation into big sectors such as financials underpinning a US market advance in 2017, but are cautious in the short run after inflows surged and indexes set records,” he said.
“We like EM equities, based on global reflation, improving domestic economies and low valuations. Risks are further dollar strength and trade disputes.”
Meanwhile, he is neutral on European stocks, given that the weaker euro and global reflation will benefit exporters and cyclicals but there are still political, policy and trade risks on the horizon.
Nick Mustoe, chief investment officer at Invesco Perpetual, believes that Europe is the “stand-out opportunity” for global equity investors next year, especially when compared to the US equity market.
Performance of indices in 2016
Source: FE Analytics
“European companies have not re-leveraged to the same degree as their US counterparts, benefit from supportive financial conditions and still have significant scope to improve their earnings, which are a long way below their prior peak,” he reasoned.
“To put the valuation disparity between these markets in context, the US equity market hasn’t been this expensive relative to Europe for decades.”
While many believe that US equities are trading on stretched valuations, the general consensus seems to be that the market will continue to do well due to Trump’s promises of fiscal loosening.
Stanes points out that, inevitably, US politics throws up uncertainties and says the risk of disappointment, or of a policy blunder, remains significant. That said, he still takes more of an optimistic view on the US.
“If Trump’s policy priorities are focused on recharging US growth and bringing forward spending, then this is likely to boost US equities at the expense of the US treasury market,” he said.
“Furthermore, the Republican party’s control of both the presidency and Congress increases the likelihood that economic measures will get implemented, plus Congressional Democrats are likely to support infrastructure spending.
“Any vacillation in advancing the pro-growth agenda will be more related to tax cuts, where there is less of a consensus between the two parties. However, tax incentives to repatriate US companies’ global earnings could add further support to US equities, as well as drive merger and acquisition activity and share buybacks.”
The optimism shown in US markets is often linked to how healthcare and pharma stocks will fare, given the country is home to some of the biggest players in the industry.
Matthew Beesley, head of global equities at Henderson, says that healthcare – along with the impact of technology on our lives – will be the key themes that are likely to shape where he invests in 2017.
“The issue of balancing the need to meet the healthcare requirements of an ageing population while maintaining cost-efficient solutions is likely to mean that only those healthcare companies that can offer true economically-adjusted health benefits will prosper,” he explained.
“The gap between those companies that have truly innovative products and those that are relying on ‘me too innovation’ and incrementalism is likely to widen in terms of long-term investment performance.”
Geir Lode, head of global equities at Hermes Investment Management, says that one of his main concerns when looking ahead is the impact of pricing pressure on the healthcare sector.
He warns: “Pharmacy benefit managers are squeezing the margins of drug manufacturers, while a price war has erupted among distributors, undermining profitability as the industry adjusts to a new environment.
“Companies with limited ability to innovate will struggle and there will be an increased pressure on companies relying on patents and price hikes to grow earnings.”
Not everybody is cautious on the sector though. BlackRock’s Turnill is positive on healthcare stocks due to their ability to grow dividends and says that valuations in the market area are attractive.
Performance of indices in 2016
Source: FE Analytics
“Healthcare stocks look cheap, reflecting ongoing downward pressure on drug prices and uncertainties over a potential dismantling of Obamacare, but we see long-term growth in demand,” he said.
“We recognise a risk of temporary pull-backs but believe the rotation into cyclical and value stocks can push the broad US market to positive returns in 2017.”
Elsewhere, the rotation into value over the last few months seems set to continue, according to many global equity specialists.
Marcus Brookes, head of multi-manager and Robin McDonald, multi-manager fund manager at Schroders, say their outlook for next year is heavily influenced by the likelihood that inflation surprises on the high side over the next few quarters.
While economically sensitive groups such as mining and banks have struggled through much of the year, they say their sudden surge in performance could well continue throughout 2017.
“In our view, this bull market in safety was always likely to climax with a shift in expectations towards better nominal growth. With higher inflation pretty well assured for the first half of 2017, Donald Trump’s election has (rightly or wrongly) now given the market a more pro-growth narrative on top,” they said.
“What we are talking about here is a window of opportunity between now and the next recession to benefit from a period of mean reversion, as the extreme crowding in bonds, bond proxies and yield plays dissipates and owners of those assets suffer drawdowns.
“To summarise our view on equities, we believe the rotation that began in February of this year and accelerated post the US election has legs. This is most beneficial towards the “value” style, where the majority of our equity assets are currently concentrated.”