Capital Markets Update: January 2018

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

Capital Markets Update

  • Bullish about growth
  • Overdue market correction comes and goes
  • Trump talks global trade

 
In a nutshell

January saw equity markets continue rising, as 2018 seemingly began where 2017 left off. The consensus among analysts and market commentators in their new year reports was overwhelmingly positive on the prospects for 2018. Their views no doubt contributed to investors’ continued bullish sentiment.

Bullish about growth

The International Monetary Fund announced improved global growth forecasts for the year and that growth appears to be increasingly synchronised. Central banks across the developed world are continuing their supportive monetary policies, while large-scale fiscal stimulus, in the form of tax breaks in the US, is about to be introduced.

Overdue market correction comes and goes

When the market correction came in early February commentators pointed to a number of potential catalysts.  In the US, improvements in leading economic indicators, most notably in the employment numbers, fuelled inflation concerns. This led to conclusions that the Federal Reserve would have to raise interest rates higher and faster than forecast. There were also worries over central bank competency, following the appointment of a new Chair at the Fed. Some pointed to the unwinding of complex derivative based investment strategies that had been used by investors to profit from an extended period of low market volatility as exacerbating the problem. Profit taking was not one of the reasons commonly cited, although we suspect it played a part given the market gains in January. Despite a historically large fall the correction only took markets back to where they began the year. It has, though, probably served as a useful reminder to investors that markets can fall as well as rise and offers a challenge to complacency.

New Fed head in spotlight

In the US, Janet Yellen raised interest rates by 0.25% in her final act as chairman of the Federal Reserve (Fed). Jerome Powell took over the helm in February and his appointment is expected to bring more of the same. Economic growth is evident but good news is not necessarily going to be greeted well by markets. His first day in office saw equity markets fall significantly.

The ongoing improvements in US unemployment numbers were met by a fear of subsequent wage inflationary pressures which, in turn, would force the Fed to raise rates faster than planned. This fear becomes even more pressing given the inflationary potential of the imminent tax reforms from US president Donald Trump’s administration. An environment of rising rates doesn’t tend to be good for equities but the planned fiscal stimulus in the US combined with a favourable economic backdrop and positive corporate earnings surprises should support the current bull market. The Fed may also be comfortable letting the economy overheat for a little while and wage inflation isn’t necessarily a given in the near term.

Trump more positive on global trade

Trump gave his State of the Union address and attended the World Economic Forum in Davos. In both, he sent a message that was more positive on global trade than his previous protectionist stance would have indicated. Meanwhile, a more conservative position on infrastructure investment and the promise of lowering the costs of medicines was seen as a negative on the prospects for infrastructure and pharmaceutical companies.

Quiet start for Europe and Japan

No further detail was forthcoming on Brexit. Germany’s chancellor Angela Merkel finally managed to form a coalition government after four months of negotiation. It looks remarkably similar in formation to the last coalition, with the Social Democratic Party returning to the fold having been granted a number of concessions in order to do so. Central banks in Europe and Japan maintained their current policy positions with no interest rate rises.

Outlook

We were cautious of the bull-run in equities throughout 2017 and that stance continued into 2018. We didn’t foresee the market correction but we were alert to the possibility, which encouraged us to hold back a little. That stood us in good stead.

The threat of faster and higher interest rate rises was not good for government debt. However, our portfolios have been underweight in this asset class for some time. Our defensive approach of protecting portfolios from an environment of rising interest rates paid off this month. We adjusted our portfolios to be slightly underweight in US and UK equities, using market dips as an opportunity to buy back into the latter.

Coming into February and the market correction, the consensus was certainly bullish with plenty of investors overweight in equities. They may be a little more wary now. That said, despite an increased likelihood of volatility over the coming months there are still reasons to believe equity markets can move on from here. Over-exuberance remains a threat to which we will be alert. We will continue to seek to capture a good percentage of any market increases. At the same time, we will aim to reduce risk through diversification in our portfolios with a view to delivering a smoother investment journey for our clients.

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: February 2018. CAM06602.