While global equities continued to power ahead in 2017, it was a tough year for investors who found themselves trying to anticipate the market direction in the face of numerous headwinds.
The year began with unpredictable US president Donald Trump taking office, elections in key EU states and the ongoing uncertainty around the Brexit negotiations.
However, markets were relatively unmoved by such challenges and edged higher as ‘the most hated bull run in history’ continued.
Indeed, the MSCI AC World index – which tracks performance of stocks from developed and emerging markets indices – rose by 17.70 per cent in sterling terms during 2017.
Performance of index during 2017
Source: FE Analytics
“2017 has been another year when we were reminded just how challenging it can be to predict macroeconomic and political events,” said Ian Warmerdam, head of Janus Henderson Investors’ global equities team.
“Whether it was the early year enthusiasm for what a Trump presidency could mean for US corporate tax, healthcare reform and infrastructure spend; the path of interest rates around the world, or the ever-evolving political landscape, meant predicting these changes and the impact they would have on financial markets was as tough as ever.”
Nick Mustoe, chief investment officer of Invesco Perpetual, added: “The synchronised economic expansion that we’ve seen post the global financial crisis has helped stock markets rally and boosted the profits of many multi-nationals – creating what some might call a sweet spot for equities.
“The longer that global macro data continues to trend higher, the longer that the globally synchronised earnings upturn will remain compelling.
“Moreover, the benign global inflation environment has allowed central banks to keep monetary policy very loose – for now. However, we will not remain at that sweet spot forever, and there is reason for caution.”
Indeed, increased caution from some managers has been fuelled by the relatively unusual conditions in markets. As well as strong returns during 2017, volatility has also been lower than anticipated.
“Ten years on from the deepest financial crisis to scour the west since the second world war, volatility has all but disappeared from equity markets,” noted asset manager Rathbones.
“The global equity benchmark is basking in the third longest period without a 20 per cent correction since the 1970s. No daily setback has been greater than 1.5 per cent since September 2016 – unprecedented since 2006.”
As the below chart shows, annualised volatility in the MSCI AC World index has been edging lower over the past 10 years and has hit fresh lows more recently.
Rolling 1yr volatility of MSCI AC World over 10yrs
Source: FE Analytics
Jerry Thomas, head of global equities at Sarasin & Partners, said low volatility in markets had led to some of the best risk-adjusted returns for the past 50 years. However, he warned that such conditions were unlikely to last.
“Extremely low levels of volatility are unlikely to persist, if only because stability creates instability; when volatility picks up it is likely to be coincident with risk aversion and a decline in the equity market,” he said. “There is no way to predict exactly when this will happen, or even the extent of a market correction.”
With lower volatility seen as a result of the ultra-loose monetary policies employed by central banks across the world in response to the global financial crisis, the move towards rate tightening and stimulus withdrawal could potentially result in an increase in volatility.
However, conditions continue to suggest a more positive backdrop for global equity markets.
“Economic growth prospects are as good as they have been since the global financial crisis and there has been a real upswing in financial earnings,” added Invesco Perpetual’s Mustoe.
“Equity valuations are trending at significant premiums to their long-term average and are arguably discounting a lot of the good news with low levels of volatility, showing that investors are optimistic about prospects.”
“The risk to this scenario is that central banks have to change their monetary policy more quickly than financial markets are currently anticipating.”
Indeed, global equity markets have discounted some of the monetary policy tightening witnessed so far this year, said Alex Crooke, head of global equity income at Janus Henderson.
“One of the key lessons we have learned in 2017 is that rising interest rates do not mean the end of equity market gains,” he said.
“We have seen the US gradually push up interest rates and, at the end of the year, the UK being one of the first European markets to increase rates. Despite this, share prices have continued to rise with economic growth overriding the impact of tightening liquidity.”
From an income perspective, said Crooke, global markets are yielding up to 2.5 per cent on average, but it was possible to find stocks yielding up to 3.5 per cent and towards 4 per cent in Asia and parts of Europe.
“Those levels of dividend yield look very attractive when compared to credit and government bond yields,” he said. “The absolute level of dividend yields remains very attractive to investors when compared to other asset classes.”
Julian Bishop, global thematic analyst at Sarasin & Partners, said global equity income funds can offer better dividend cover and prospects than UK-only strategies.
“Recent data suggests that the UK was the only major global market to witness a year-on-year fall in dollar dividend payments in Q2 2017 - the first fall since the financial crisis,” he said.
“Meanwhile, global dividend growth reached a three-year high, and emerging markets saw dividend growth rate of nearly 30 per cent.
“But this is not simply an emerging market catch-up story: US dividends grew by around 10 per cent in the same period.”