Capital Markets Update: December 2017

For professional advisers only. Not to be relied upon by retail investors.

Capital Markets Update

  • US tax reforms good news for companies
  • Businesses await outcome of Brexit trade talks
  • Will market bubble burst – and when?

The year ended with US President Donald Trump’s tax reforms providing a December boost to markets. Investor attention is now focusing on the outcome of Brexit trade talks and prospects for interest rate rises.

Equities boosted by Trump tax reform

Equities enjoyed a strong December to top off a good year for this asset class. The big news was the passing of tax reform in the US. The cut in corporation tax from 35% to 21% moves the US closer to the global average. It was also a business friendly move that’s likely to benefit medium and smaller companies the most. Larger, more global companies have been able to lower their effective rate of tax over the years through careful tax planning and holding cash overseas.

The reform is also offering businesses a ‘tax holiday’ through a one-off repatriation tax. Companies will be taxed at an attractive rate on any overseas profits brought back into the country. The repatriation tax offers the opportunity for companies to bring cash back into the US to use for reinvestment or share buy backs – both positives for markets. Previous tax holidays have brought significant sums back into the US and it is hoped this will do the same.

There will also be a tax cut for the majority of households, although higher earners have been favoured. The tax cut offers a potential boost to consumption, a key driver of the US economy. The US Federal Reserve (Fed) will be keeping a close eye on the inflationary potential of this reform. It will have to decide whether to let the economy overheat a little or raise interest rates faster than currently planned.

Brexit talks transition to trade

Brexit negotiations moved on with the three key sticking points seemingly being resolved: the divorce settlement bill, rights of European Union citizens, and the Irish border. Discussions can now move onto trade and discussions about the type of agreement the UK wants. There was talk of a transition period, which will be welcomed by business, and would take some of the time pressure off. All eyes will be on the next round of negotiations.

Is market bubble set to burst?

2018 started where 2017 left off with equity markets continuing to push to record highs. When markets hit highs it is natural to look out for a correction. Some commentators feel the bubble is about to burst. Others believe there is the potential for prices to continue rising on a wave of positive investor sentiment, rather than any improvements in the fundamental underlying factors that affect share price performance. Both views set out an expectation of a market correction at some stage in the near future.

Central banks continue supporting economic growth

The question is what would be the catalyst for a market correction and how severe could it be? On the positive side, we can see signs of continued and sustainable improvements in global growth. Central banks look likely to maintain ‘loose’ monetary policy with a view to supporting their respective economies. All this should provide a solid platform for equities and bonds. At the same time, we suspect many investors are holding back cash waiting to take advantage of any market dips. We believe current market levels can be justified, but the longer this bull-run continues the stronger the case becomes for a market correction.

Outlook

It is clear central banks want to change tack and begin withdrawing from their quantitative easing programmes, either by raising interest rates, buying less bonds or a combination of the two. The Fed has managed this process well so far and has set a good template for others to follow. But the actions of central banks will continue to shape the outlook for bonds and equities.

Donald Trump aside, the western political stage looks fairly stable given the wave of national elections in 2017. Elections in Italy and some key emerging market countries are due in 2018. We would expect to see much greater clarity around Brexit over the coming months. The conclusions reached will influence the fortunes of the UK stock market and economy. There is the potential for equity markets to move higher from here but we will be alert to signs of over-enthusiasm in markets. We do not want to miss out on any upside from equities but will remain wary of a potential correction.

Oliver Wallin, Octopus Investments

e: owallin@octopusinvestments.com

t: +44 (0)20 7776 3153

 

Important information:

For professional advisers only. Not to be relied upon by retail investors. The value of an investment, and any income from it, can fall or rise. Investors may not get back the full amount they invest. Past performance is not a reliable indicator of future results. Personal opinions may change and should not be seen as advice or a recommendation. Issued by Octopus Investments Limited, which is authorised and regulated by the Financial Conduct Authority. Registered office: 33 Holborn, London, EC1N 2HT. Registered in England and Wales No. 03942880. Issued: December 2017. CAM06402.