The UK’s move to leave the EU, continued nervousness around emerging markets and the underperformance of precious metals are some of the ‘walls of worry’ that investors will have to deal with in 2018, according to AJ Bell investment director Russ Mould.
“The old saying ‘markets like to climb a wall of worry’ proved spot on in 2017,” Mould said. “Concerns over what president Trump may or may not do, North Korea, China’s economy, the Brexit talks and a gradual series of US Federal Reserve interest rate increases were all swept aside as global stock markets moved higher and bonds did not suffer the accident many had feared.”
Despite the above concerns, 2017 to date has been a fairly robust one for investors with the FTSE All Share making a 10 per cent total return while the MSCI World is up 12.5 per cent; emerging markets were ahead more than 20 per cent, with China performing especially well.
Below, Mould highlights five areas of concern as we move into 2018, as well as what might cause them to surprise investors on the upside.
Brexit talks, the pound and the UK stock market
The investment director noted that investor sentiment toward the UK’s equity market continues to be dominated by the uncertainty surrounding the ongoing Brexit negotiations. What they may mean for the broader British economy and the pound will be closely debated in 2018.
Along with this is the perceived political risk as investors watch a government without a majority and the presence of an increasingly popular opposition party that is not the friendliest towards markets, which investors are eyeing with nervousness.
Performance of indices over 2016 and 2017-to-date
Source: FE Analytics
“The UK underperformed the FTSE All World in sterling total return terms in both 2016 and 2017 and comes with a currency which looks cheap on a purchasing power parity basis,” Mould said. “It may not take much for the UK stock market to surprise on the upside in 2018, especially as the index could derive support from its projected 4.3 per cent dividend yield.”
Retailers
The second wall of worry highlighted by AJ Bell is retail stocks, which have suffered in the recent past because of several factors, not least the rise of online shopping contributing to the demise of the high street.
Mould highlighted fears such as the ‘Amazon effect’, the impact of sticky inflation on consumer spending power and weak consumer confidence as negatives facing retailers, although he does see some potential for upside.
“Several very profitable names are now looking cheap and offer fat dividend yields for good measure and if history is any guide this is one sector which could do well were the pound to surprise by rallying (either as the Brexit talks go smoothly, the Bank of England moves more quickly than expected or something goes wrong elsewhere),” he said.
Japan
Japan, which is the world’s third largest economy, has performed strongly over recent years on the back of the ambitious stimulus package known as Abenomics; FE Analytics shows the Nikkei 225 index has beaten the MSCI World over one and three years.
However, Japanese equities are still behind global stocks over longer time frames and investors remain nervous about allocating to the country after being hit by significant losses several decades ago.
Performance of indices over 10yrs
Source: FE Analytics
“Japan is a mystery to many, with a debt-to-GDP ratio that would embarrass Greece, unhelpful demographics and a corporate landscape where 2017’s headlines are dominated by misreporting or accounting scandals at Toshiba, Kobe Steel and others,” Mould explained.
“But the political situation is stable, corporate governance is improving thanks to the launch of the JPX-Nikkei 400 index, the economy has just put together its best run of growth in a decade and the headline Nikkei 225 index does not look expensive relative to its history on earnings, not least because it still trades more than 40 per cent below its 1989 peak.”
Emerging markets
Until 2016, emerging market equities had been relatively unloved by investors for a number of years. FE Analytics shows the MSCI Emerging Market index made a 10.65 per cent loss over the three years to the end of 2015, while the MSCI World surged by 45.32 per cent.
Performance has turned around more recently yet investors highlight a range of issues with the asset class. But Mould pointed to several positives around emerging market equities.
“After several years in the wilderness, emerging markets have had two good years, buoyed by improving global growth, a weak dollar and drops in inflation which means interest rates are falling in major countries, not rising as in the west,” he said.
Performance of indices over 5rs
Source: FE Analytics
“They are still treated with scepticism in many quarters, owing to their commodity exposure (Brazil, Russia) or political risk (Mexico owing to NAFTA talks, South Africa or Brazil again) and this may mean there is selective value to be had,” he continued. “Emerging markets overall are not expensive on a price/book basis at around 1.7x compared to cyclical peaks north of 3.0 and there is gathering yield support in some markets too.”
Precious metals
The final wall of worry highlighted by the AJ Bell investor director are gold and silver, which have gone through a relatively lacklustre year and some are saying look threatened by the sudden rise of cryptocurrencies.
However, Mould pointed out that next year could see more factors come into play that support the investment case for precious metals and will prevent their position in portfolios from being usurped by cryptocurrencies such as Bitcoin, which many fear is currently in a bubble.
“In dollar terms silver is broadly flat this year and gold up by some 10 per cent, returns which pale next to those made by Bitcoin and it does look as if bulls of the precious metals are throwing in the towel, lured away by cryptocurrencies or the prospect of rising interest rates or both,” he said.
“Yet if inflation does begin to surprise on the upside gold and silver still have the potential to come back into favour, especially as sentiment seems so washed out.”