It is unlikely 2017 will offer as clement an investment climate as 2016, but the outlook is still upbeat.
As the New Year dawns, investment managers have some sense of relief if they can report decent positive returns for the year just ended. 2016 was generally a good year for UK investors. UK bonds produced an excellent return over the year as a whole, despite the fall in prices in the last few months. The continuation of quantitative easing (QE) programmes of bond buying in both Japan and the euro area was augmented by a return to such action in the UK as well, underpinning prices. Interest rates remained very low in the advanced economies as we expected. As a result bonds shone in the first part of the year as investors hunted the ever vanishing yields available. A sell off towards the end of the year on justified expectations of a US rate rise still left annual returns in strongly positive territory in most cases.
UK shares overall did well. Practically all foreign markets delivered good returns if you held the shares in their own currency at a time of sterling weakness. Most portfolios will be reporting returns usefully above the rate of inflation, with better rewards for those who took more risk.
UK large company shares and US shares generally did much better than European or Japanese shares over 2016, reflecting the greater strength of the US and UK economies. Indeed, if you invested in Japan and the euro area with currency protection into sterling, you did not make money. The best-performing markets were Brazil and Russia. Brazil rallied after a collapse based on the recession and political turmoil in the country, as investors look forward to a more stable economic policy and some recovery from the low levels reached during the period of despair last year. Russia benefitted from the strong rise in the oil price from the February lows. Investors also did well in emerging markets generally. The Chinese domestic market was the one to avoid, as we advised during the year. It is taking time to sort out that market after the boom and bust cycle it experienced in 2015.
It is unlikely 2017 will offer as clement an investment climate as 2016 proved to be. Further rate rises are likely in the USA. The UK is unlikely to need to cut rates again or to print more money to buy bonds. Japan may well continue with a large QE programme, but has made clear it wants to keep the ten year yield at zero with higher rates for longer duration, so it is no longer trying to drive these rates down more. The German influence on the Eurozone would like to start weaning it off large bond buying programmes, though the authorities seem intent on “doing what it takes” to avoid a further deterioration in output. They may decide to taper the programmes in due course. All this makes it unlikely advanced country sovereign bonds will deliver such good returns in 2017.
There is more going for shares, despite the price rises in 2016. The world economy should grow around 3% again this year as last. Attention will concentrate on Mr Trump’s progress with reflating the economy. So far markets have been enthusiastic about his ideas of expanded infrastructure investment and large tax cuts for both companies and individuals. 2017 will be a year which tests his skills at getting his programmes through Congress, given that some Republicans as well as all Democrats are sceptical about their new leader. It will also define what Mr Trump actually will do on trade. His rhetoric has been menacing to free trade in general and the China trade in particular. We may find that in practice he has limited options and is talked out of anything dramatic. Overall we expect Mr Trump to be a positive for economic growth.
We expect the UK to grow a little over 2% this year, as last. This is out of line with the fashionable gloom about UK economic prospects based on worries that inflation will pick up, eclipsing wage growth and leading to a sharp fall in consumer activity. We think real incomes should continue to grow a bit this year. Inflation will of course rise to some extent, particularly owing to the increase in oil prices and its direct impact on driving costs. Fears of general price rises on the back of a lower pound are probably overstated. The background is generally benign for UK companies, made more competitive by the lower pound. Jobs growth has been good and wages, bonuses and overtime have been increasing. Government has been keen to promote higher wages at the lower end.
The euro area should make some more progress with general recovery, aided by the repair of more of the damaged banks. The problems it faces are largely political, with a series of elections in the Netherland, France, Germany and probably Italy posing a challenge to the current EU and euro area policies.
China continues to expand at a decent pace, but may this year have to announce a modestly lower official growth rate going forward. The long transition to an economy based more on services and domestic consumption, and less on industry and exports, still means pain ahead as mines and factories are closed to bring output into line with market needs.
For 2017, we favour share investments more than government bonds where portfolios can accept such risks. The arrival of Mr Trump in office will produce changes which present opportunities as well as threats to investors. We will seek to keep you posted as his team transform tweets and sound-bites into policy.
The above article by John Redwood, Charles Stanley’s Chief Global Strategist, was first published by Charles Stanley on 3rd January 2017.