Looking back, looking forward

Despite the somewhat dramatic events of 2016, global equities produced another solid return for investors, as equity markets continued to climb the wall of fear. According to the Financial Times this was the worst year for active managers since 2007. They started the year overweight Europe, underweight the US. Fund managers have been consensual in their views over the past few years, and this year was no exception. Fund managers also started the year once again favouring growth sectors over value ones. In the event the US out performed Europe and equities had one of the biggest sector rotations in the past 30 years from growth to value. 

 A further $4tn of deals announced in 2016, made it another busy year within Investment Bank’s corporate finance departments.  The FTSE 100 closed the year 14.4% higher despite Brexit, climbing over 25% from the lows in mid-February. However, the weakness in the pound meant in dollar terms the FTSE 100 lost 5%. The MSCI All World Index closed the year up over 5% (USD). The best performing of the major equity markets this year will be Russia’s RTS, the worst the Shanghai Composite. The S&P 500 finished the year up circa 10%, the Euro Stoxx 50 close to where it started the year (before dividends).

Equity markets had an uncertain start to 2016. The turning point came in February when Jamie Dimon, the JP Morgan CEO, had invested $25m of his own money into the company shares after they had fallen 20% from the start of the year.

At the start of the second quarter, investor’s focus turned to the upcoming Brexit vote. Despite a poor campaign from the Remainers, expectations were that Britain would ultimately vote to maintain the status quo. As we now know this did not occur. Sterling fell, so did stocks, but in the case of stocks, only briefly. The boost to earnings from the fall in the pound, alongside the Bank of England’s stimulus measures, meant the UK equity market recovered sharply in July.

The summer months were uneventful. Equity markets were conspicuous by their lack of volatility. Then came the lead up to November’s US presidential election. Again, expectations were that voters would turn their back on change and go for the security of another Clinton. As with Brexit any other outcome, was considered to have negative implications for equity markets. Investors were strangely nervous of the possibility of a pro-business president being elected along with a pro-business republican party.

As it transpired Donald Trump’s election sent US stocks to record highs. The final act of the year was for the Federal Reserve to raise rates in December, for the only time in 2016.

Looking to the year ahead reflation has become the new watch word for investors for 2017, as many commentators are speculating the long bull market in bonds is coming to an end. Investor sentiment, at least in the short term, improved dramatically on the back of expectations that the Trump presidency will bring more liberal fiscal policies.

This improvement in sentiment can be seen anecdotally in several ways. The AAII retail investor sentiment survey remains above historic averages, having spent large parts of the year below this level.  A recent CNBC report noted that the Wells Fargo/Gallup Investor and Retirement Optimism Index rose to 96 last month, the third straight quarterly rise, and is now back to levels last seen in May 2007.  Merrill Lynch also reported cash held by fund managers, as a proportion of the overall portfolio, has fallen in the past few months. The recent strength in the US economy, and continued growth for the Chinese economy has contributed to this optimistic outlook for the year ahead.

What events could stretch investor nerves in the coming year? The obvious one will be any signs economic growth in the two largest economies in the world is slowing. The Chinese yuan has fallen sharply this year as capital has flowed from the region. This has the potential to cause further instability in the global economy. Politics in Europe will remain centre stage, with several countries, including France and Germany, facing presidential elections. Continued strength in the US dollar could put further pressure on emerging economies.

Should this surge of optimism be another risk for 2017? Bull markets are said to be born on a wave of pessimism, then grow in a period of scepticism, and die in euphoria. We have seen the first two, the question now is, are we reaching the third phase? Possibly in the short-term at least.

Equity investors have had a good year, and some may look to book profits. Should they do so they will continue to face the conundrum of a lack of alternative to equities, particularly when it comes to income. Cash in the bank continues to offer no return, bonds slightly better, but again yields remain close to historic lows, and in the case of UK equities the ten-year gilt yield remains below that of the yield of the FTSE 100.  

Posted on January 3, 2017 .