Investors now have little alternative but to support risk assets if they want to beat inflation, affirms one of the world’s largest independent financial advisory organisations.
The assertion from Tom Elliott, International Investment Strategist at deVere Group, comes as global stock markets enter 2018 with positive momentum, including the Dow Jones which has surpassed 25,000 for the first time in history.
Mr Elliott explains: “Market confidence is supported by a reasonably strong cyclical upswing in world GDP growth. This is being translated into corporate earnings growth, by a belief that central banks will not significantly tighten monetary policy unless justified by growth and inflation data, and by the U.S. corporate tax cuts announced in December which will boost Wall Street corporate earnings.
“In the face of continuing low interest rates and bond yields, investors now have little alternative but to support risk assets such as equities and non-core government bonds, if they want a yield that will beat inflation.”
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An acronym is currently being popularised that describes how many investors see markets unfolding in 2018: MOTS, standing for ‘more of the same’. That is to say, solid returns for stock markets with continuing low volatility, and positive returns from investment grade corporate bonds.
“The risks to the MOTS scenario include central bank policy error, Trump turning America away from its traditional support for free trade, a credit crunch in the Chinese financial system and from geopolitics such as North Korea and the Middle East. However, as supporters of MOTS would argue, none of these risks are particularly new and they failed to de-rail markets in 2017,” confirms the strategist.
He continues: “We favour a long-term multi-asset approach to investing, whereby investors choose a suitable combination of global equities and bonds – depending on their risk profile and investment horizon – and leave the portfolio unchanged. Regular re-balancing ensures winners are sold and losers are bought – which financial history, and common sense, supports but which is so hard for us to do in practice.”
Mr Elliott goes on to say: “Looking forward to 2018, Japanese and emerging market stock markets appear to some commentators to offer most value, the U.S. less so. The Japanese economy, which grew at an annualised rate of 1.4% in the third quarter 2017 (despite a shrinking population), continues to benefit from a weak yen and the upturn in global demand for its exports. Fiscal reform, in particular lower corporate tax rates for companies that increase wages by 3% or more, comes into effect in April. It is hoped that this will lead to improvements in household demand growth, which has been weak in recent years. Emerging market equities continue to look undervalued relative to their developed market peers on most valuation measures, despite their outperformance in 2017.
“Wall Street is the most overvalued of the major stock markets, with the attractiveness of equities against bonds diminishing as Treasury yields creep up. However, the increase in yields is likely to be modest and U.S. corporate earnings growth will remain strong, limiting any pull-back in share prices. The weak dollar boosts export earnings, while strong consumer confidence supports domestic-focused sectors. Tax cuts will be a net benefit to U.S. corporate earnings, but the impact of changes to the tax code on individual sectors is as yet unpredictable. Fourth quarter earnings statements and outlook comments, from mid-January, will hopefully offer clues.”
Mr Elliott is not so confident about fixed income. He concludes: “Once again we begin the year with commentators generally nervous of bonds, fearing that an inflation problem is around the corner. Some fear that central banks will tighten monetary policy faster than is priced into the market in an accelerated effort to ‘normalise’ policy.
“It seems prudent to heed such warnings, even while acknowledging that the fear of imminent inflation has been voiced by monetarist hawks – and proved wrong- ever since central bank’s policies of quantitative easing and ultra-low interest rates began nearly 10 years ago. This suggests favouring short duration core government bonds, since the cash can be re-invested in a few years in higher bond yields.”