WE SPENT much of 2017 referring to market events as being boring. Asset prices basically went up in a straight line and there was a near-total absence of volatility across all major asset markets.
We have firmly left that ‘Easy Street’ environment and investors are now once again being forced to think about the possibility of markets going down as well as up. The regime change that has taken place over the last few months brings both a number of risks and opportunities, as well an overarching necessity for investors to reassess the likely bumpy future path for asset markets and to recognise that investment returns are likely to be lower in the future than they have been over the short, medium and long-term history.
Let’s start with the positive aspects of the global economy. Growth around the world remains positive, even if the overall rate of growth has slipped from strong at the end of 2017 to solid, but unspectacular today. The areas where growth appears to have cooled most significantly are China and Europe and this has been reflected in the underperformance of their equity markets so far this year.
Europe has drifted back towards its unimpressive long-term trend growth rate, weighed down by reduced levels of confidence, fulfilled demand and lingering concerns over debt, while the Chinese authorities have tried to guide their own economy towards a more sustainable and sensible level of growth. That said, we should remember that while growth rates have slowed, both of those regions are still growing and helping boost corporate profits at companies around the world.
The most positive news comes from the US, which has grabbed the yellow jersey both in terms of economic growth and the performance of the stock market there. The fiscal stimulus that has been injected into the American economy by the Trump administration, as well as a concerted effort by the government to reduce onerous red tape, has spurred economic growth and it is obvious that the immediate outlook for the economy across the Atlantic is sound.
Investors should remember that investment is a forward-looking game and rather than simply focusing on the few months ahead they should think about the next few years. This is where the risks become more obvious, particularly if you take the view that we have that the short-term positive boost to economic growth caused by the fiscal stimulus applied in the US will eventually lead us back to the boom and bust cycles that we saw before 2008.
Debts levels globally, but most obviously in the US, are growing ever higher and we are very concerned about the crowding-out effects that all of the deluge of government debt issuance will have upon private capital markets.
Inflation risks are now starting to build throughout the global economy, as labour markets become tighter and companies struggle to fill jobs with skilled workers.
This has finally led to appreciating wages, something which has been absent for much of the recovery that the global economy has enjoyed since the financial crisis of 2008-09.
This is clearly good news for consumers, but higher wages will eat into the profits of companies unless they can raise prices of products or services that they sell on.
When one combines the changing events of the last few months with the threat of a full-blown trade war between the US and its economic friends and foes, it is clear to see why we have seen growing tensions across financial markets.
While we don’t view the new market regime as one where investors should sell up entirely and head for the hills, it is a time to assess whether the investments and asset allocation that you have held for the last decade are still appropriate for a time when risks have risen and returns are likely to be lower.
The days of the certainty of low interest rates, low levels of inflation and ever-widening corporate profit margins are now behind us.
Tim Wishart is head of Scotland at Psigma Investment Management.
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