Q1-2018 Quarterly perspectives

Tavistock Wealth - Investment Team Outlook
Welcome to the inaugural ‘Quarterly Perspectives’ publication, which aims to explain our outlook for financial markets over the coming year.
2017 was a year of steady gains and low volatility. Few people saw it coming. Now, tradition dictates we make predictions for the year to come. Before doing so, it’s worth clarifying two points. Firstly, no-one knows what will happen this year – many commentators will be wrong about their expectations for 2018. Secondly, timing is everything and very difficult to get right. In the long run, market fundamentals are driven by economic growth and valuations, but these have little impact in the short term.

Key Themes

We see a continuation of synchronised global growth and a modest pick-up in inflation throughout 2018. Key risks to this outlook are that growth may disappoint and inflation may surprise to the upside. Another key theme is that 2018 will be the year central bank bond flows turn negative, spelling a symbolic end to the great bond bull market. The current bull market, in equities and bonds, has been characterised by high valuations and low volatility, which has reduced perceptions of market risk. This leaves markets vulnerable to a correction. Potential geopolitical triggers include North Korea, the ongoing conflict between Saudi Arabia & Iran, Italian elections in March and the EU deadline for a final Brexit agreement in October.

Chart of the Quarter

Our chart of the quarter highlights the convergence in US yields. For the first time in almost 10 years, the 2 year Treasury yield is back above the S&P 500 dividend yield. Equities remain our preferred asset class and this is likely to remain the case throughout 2018. But as bond yields rise further, this relative preference for equities over fixed income may start to dissipate. We see this as more of an issue for equities in 2019.

Fixed Income

Fixed income markets in 2017 were characterised by multiple hawkish events, each of which failed to materialise in significant bond market volatility. The US Federal Reserve began tapering its balance sheet, named a new chairman and hiked interest rates 3 times. The European Central Bank announced plans to reduce its monthly bond purchases and the Bank of England raised rates for the first time in 10 years. However, the Bank of Japan’s surprise cut to JGB purchases last week, proved something of an inflection point as central banks step further back from ultra-accommodative monetary policy.

We expect the Federal Reserve to raise rates at least 3 times in 2018. As such we remain underweight US Treasuries overall and tactically positioned for further yield curve flattening. We have a neutral view on US investment grade and high yield debt. Whilst high valuations cap further upside gains, higher yields and lower default rates should provide some protection against a gradual increase in interest rates, particularly in short dated maturities. Our highest conviction is Emerging Market Local Currency debt. Our view is supported by sustained global economic growth, benign inflation and ongoing US Dollar weakness.

The gap between 2 and 10 Year Treasury Yields is at its lowest level since the financial crisis.

Equities

Global equity markets reached all-time highs in 2017, with the MSCI World gaining 20.11% as the synchronised global growth phenomena showed no signs of abating. Strong economic data coupled with the passing of Trump’s tax cuts saw all major US equity indices set successive record highs.

Despite stretched valuations, particularly in the US, we see room to run in global equities as we enter 2018. We particularly favour Emerging Market and European equities, given the relative attractiveness in their valuations and forecast earnings growth. Sector-wise, we maintain a positive outlook for financials in Europe and in the US.

Whilst the ‘momentum’ factor that outperformed in 2017 (led by technology companies) should continue to do well, we increasingly like ‘value’ stocks (dominated by financials), which have made recent gains and should outperform in any momentum led sell-off. We have implemented this theme via the adoption of smart beta equity strategies.

The greatest risk to the current bull market run is sharper-than-expected monetary policy tightening and withdrawal of liquidity.

Since the financial crisis, the US has led the global economic recovery, translating into sizeable equity market outperformance vis-à-vis its developed market counterparts.

Alternatives

This quarter we focus on commodities. Overall, commodity prices showed strong performance in 2017. The S&P Goldman Sachs Commodity Index (GSCI) returned 5.77%, ending the year at a two-year high. We have a positive view on commodities for 2018, supported by synchronised global growth and the strong rebound of international trade flows over the last year.

As an energy-intensive index, the GSCI benefitted from the rise in oil prices driven in part by efforts led by OPEC and Russia to curb production. Key factors that will shape oil’s future in 2018 are continuing global growth, geopolitical risks in the Middle East, the extension of OPEC cuts and forecast growth for non-OPEC supply, particularly from US shale.

Our largest position within commodities is Global Infrastructure, which has 56% exposure to the US. Infrastructure was singled out as a key part of Donald Trump’s legislative agenda for 2018. Passing an infrastructure bill should be possible given bi-partisan support although Congress would need to reach an agreement on funding.

Gold was up 13.11% during 2017, bolstered by a weaker US Dollar and heightened geo-political risks. Heightened risk going forward supports the tactical use of Gold as a policy and tail risk hedge and as such we maintain a small position in Gold Producers.

Oil prices have been positively correlated with EUR/USD since early 2000. Whilst the relationship is complex, operating through multiple channels, our EUR/USD forecast might also mean higher oil prices.

Foreign Exchange

We are bullish the Euro and bearish the Dollar going into 2018. The US Dollar index lost almost 10% in 2017 and this weakness looks set to continue as central bank policy convergence disproportionately benefits catch-up economies to the disadvantage of the US Dollar. Meanwhile, the Euro, which is the largest component of the US Dollar trade weighted index, should strengthen as the ECB phases out bond purchases beyond September 2018.

We also retain a positive view on Sterling. The currency remains fundamentally undervalued, pricing in significant Brexit related risk, and as such we do not believe Sterling is setup for a major fall. Conversely, a general election or second Brexit referendum, however unlikely, could infer significant upside potential. Finally, we suspect the BoE may raise rates further this year, providing additional support.

This investment Blog is published and provided for informational purposes only. The information in the Blog constitutes the author’s own opinions. None of the information contained in the Blog constitutes a recommendation that any particular investment strategy is suitable for any specific person. Source of data: Tavistock Wealth Limited and Lipper for Investment Management. Date of data: 15th January 2018

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