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The outlook for markets, politics, sectors, takeovers, commodities, house prices and more
Thursday 14 Dec 2017 Author: Daniel Coatsworth

The markets approach the New Year in a fairly resilient mood, characterised by decent earnings growth from companies, several examples of M&A activity and the end of another year in what has been a long bull-run.

Although the general public may be fixated with Bitcoin at present, we believe there are plenty of opportunities for your money in the UK market and overseas, as we explain in this feature. As always, you’ll have to do some digging to separate the potential winners and losers.

We now discuss 10 of the big questions facing investors in 2018 and how you can apply this information to your investment decision-making.


1. WHAT WILL HAPPEN TO THE UK STOCK MARKET IN 2018?

It’s the question everyone’s asking given the widely held perception that many UK equities are trading on bubble-like valuations and that the stock market rally is soon to end.

Fanning the flames of the bubble argument is the fact that the FTSE 100 has set new record highs several times in 2017 including the all-time high of 7,562.28 on 6 November.

The UK stock market has rallied strongly since the financial collapse, more than doubling from the 6 March 2009 nadir of 3,530.73. The FTSE 100 has risen by nearly 30% since February 2016.

Stock prices may have been rising for eight years but, as Trevor Greetham, head of multi-asset at Royal London Asset Management, neatly puts it, ‘bull markets don’t die of old age’.

THE UK MARKET IN 2017 WASN’T AS STRONG AS YOU MIGHT THINK

While records have been broken on many stock markets this year (such as the S&P 500 and Dow Jones in the US and Nikkei 225 in Japan), the overall performance in the UK has been more circumspect and divergent.

The FTSE 100 has only risen by 2.9% year-to-date, and that’s with the tailwind of the lower pound.

For every NMC Health (NMC) or Intertek (ITRK) roaring ahead this year, there have been the likes of Centrica (CNA) and BT (BT.A) which have done miserably.

‘A correction is overdue,’ argues Mark Slater, founder and manager of the Slater Income Fund (GB00B6YSXJ10), yet he remains quite optimistic when it comes to finding investment opportunities.

Slater’s fund invests right across the market sector and size spectrum and he believes there remain a lot of UK opportunities where the ‘valuations are very attractive.’ He cites examples such as Lloyds Bank (LLOY), Liontrust Asset Management (LIO) and Amino Technologies (AMO:AIM).

This view appears to be widely held by UK fund managers. More than two-thirds expect the global equity bull run to continue throughout 2018, according to a recent Reuters poll. Indeed, many fund managers have been upping exposure to UK stocks.

The debate about whether UK equities valuations are good, bad or indifferent could run endlessly. But it is worth remembering that many smart fund managers have called temporary time on UK equity good times before, only to be left with egg on their faces. (SF)

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2. OVERSEAS MARKETS: WHICH ONES WILL BE HOT IN 2018?

Europe has been one of the success stories in terms of stock markets in 2017 and that trend looks set to continue in 2018, according to investment experts.

‘After a decade when Stoxx 600 earnings have declined, 2017 is set to break that trend and deliver double-digit earnings growth,’ says James Rutherford, chief investment officer, European equities at Hermes. ‘Estimates for 2018 are rapidly changing, but current consensus is around 8% growth.’

Stoxx 600 is an index of large, mid and small cap companies across 17 European countries. It has increased in value by 10.6% for the 12 months to 6 December 2017.

Investment bank Morgan Stanley is also bullish on Europe. It believes the European Central Bank will maintain an ‘extremely easy’ monetary policy and that GDP for the Eurozone could increase by more than 2% for the second year in a row, followed by 1.9% in 2019 (the latter on a par with the US).

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OUTLOOK FOR EMERGING MARKETS AND THE US

Emerging markets could be more volatile in 2018. Widespread expectation for higher interest rates in the US near term could cause inflationary pressure in emerging markets, warns Bank of America Merrill Lynch.

UBS takes a positive view, predicting 8% to 10% returns in emerging markets equities in 2018, driven entirely by earnings growth.

The main US stock indices have soared ahead in 2017 yet valuations aren’t overly excessive and the macro backdrop remains supportive. Proposed tax cuts should boost corporate profits. UBS predicts 7% to 9% total returns from the S&P 500 index in 2018.

Luca Paolini, chief strategist at Pictet Asset Management, says dollar weakness and Trump’s tax plan should support US corporate earnings and boost the market. However, he believes European, Japanese and emerging markets equities have ‘even better’ prospects.

GAINING EXPOSURE VIA FUNDS AND ETFS

Anyone looking for inspiration in terms of funds and exchange-traded funds to play these themes may wish to look at AJ Bell’s Favourite Funds list via www.youinvest.co.uk/investment-ideas/favourite and use that as a starting point for further research.

Europe (excluding the UK) funds on the list include: Artemis European Opportunities (GB00B6WFCR53) and Vanguard FTSE Developed Europe ex UK ETF (VERX).

US selections include: JP Morgan US Equity Income (GB00B3FJQ599) and iShares Core S&P 500 ETF Acc (CSP1).

Japan selections include: Baillie Gifford Japanese Acc (GB0006011133) and Vanguard FTSE Japan ETF (VJPN). (DC)


 

3. WHO ARE THE HOT TAKEOVER TARGETS?

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Takeover activity began to ramp up after the UK General Election in June 2017. Figures from the Office for National Statistics show the value of M&A involving UK companies hit £86.4bn in the third quarter of 2017 against just £33.2bn in the second quarter.

Apart from the £9.3bn takeover of payment processing firm Worldpay (WPG) in August and a more recent deals involving a tie-up between shopping centre investors Hammerson (HMSO) and Intu Properties (INTU), most of the high-profile bid targets on the UK market remain unconsummated for now. This could change in 2018 as attention moves on from political concerns.

PLENTY OF FIREPOWER TO DO DEALS

Many companies and private equity firms are sitting on mountains of cash. According to industry consultant Preqin global private equity has nearly $1tn in capital at its disposal.

The pound is volatile but remains broadly depressed against other major currencies and this should make UK companies attractive to overseas buyers in particular.

On the flip-side the reason the pound is weak is due to continuing uncertainty over the Brexit process and the risk of a radical Labour government being formed in the UK. Both these factors could limit deal appetite.

The transition agreement on Brexit craved by the corporate world could address both issues by providing greater clarity on the future trading arrangements between the UK and EU as well as bolstering the position of the current Government.

VALUATION SHOULD NOT BE AN OBSTACLE

Valuation is unlikely to be a major issue as UK stocks have materially underperformed US and European equities in 2017.

Many of those with UK domestic exposure really struggled. For example, free-to-air broadcaster ITV (ITV) is down 22% year-to-date thanks to a gloomy advertising backdrop. This could provide the spur for its largest shareholder Liberty Global to make a takeover bid.

In our view ITV is the M&A candidate with the most potential, given a clearly identifiable suitor, its status as a unique asset and a free cash flow yield of nearly 10% based on Liberum’s forecasts – way above the likely cost of financing any deal.

Some companies which have previously fought off bid interest remain potential targets, according to many market commentators, including AstraZeneca (AZN) and Unilever (ULVR).

Goldman Sachs recently published a list of potential M&A targets including media group Ascential (ASCL), tech firm Aveva (AVV), oil producer Tullow Oil (TLW), medical devices expert Smith & Nephew (SN.), recruitment agency PageGroup (PAGE) and chemicals business Croda (CRDA). (TS)


4.  CAN THE RETAIL SECTOR BOUNCE BACK?

The UK retail sector has been depressed in 2017.Profit warnings and worries over the consumer outlook have weighed heavily on sentiment.

Sector headwinds are numerous; higher inflation, falling real disposable income, weakening consumer confidence, unsecured debts rising ahead of income, and disruption from online-only operators.

Retailers face rising costs in the form of the National Living Wage, pensions auto-enrolment and necessary investment in their online infrastructure.

But as stockbroker Peel Hunt recently commented: ‘The consumer is still spending’. That suggests you shouldn’t write off the retail sector from an investment perspective.

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WHAT’S HOT AND WHAT’S NOT?

Home-related spending and big ticket items are the only areas to have suffered a visible slowdown. Times are tough, but good retailers are still taking share and delivering sales and profit growth.

‘We are certainly not going to argue that all is rosy in the garden, but we believe that while the consumer is facing clear headwinds, those headwinds remain a long way from being recessionary or devastating in effect,’ says Peel Hunt.

It is worth noting a recent bullish comment from Simon Wolfson, boss of retailer Next (NXT). He said: ‘Our prospects going forward appear somewhat less challenging than they did six months ago. I think potentially we have reached the bottom of a number of adverse trends.’

REASONS TO BE CHEERFUL?

There will be less pressure in 2018 on retailers to raise prices, since the bulk of inflationary input costs have now worked into the system.

As N+1 Singer’s retail expert Matthew McEachran explains: ‘The £/$ fall from 1.50 to 1.20 was the cause of a lot of the sector’s issues – firstly on margin (import costs) and now on sales (real wage squeeze). The rate has recently recovered half the gap (now roughly 1.35) meaning not just that the imported inflation bit will stabilise, but that it will part reverse (all else being equal).’

McEachran also guides towards the possibility that real wages could feasibly turn positive again in the second half of 2018, an important theme, not least as retail winners might also benefit from market share gains following a shake out of weaker operators.

The 2018 outlook remains positive for e-commerce as a whole, with online channel shift accelerating and by increased physical space contraction and capacity withdrawal.

In the New Year, other themes to monitor may include trading down to value goods and services.

For investors prepared to look past lofty valuations ASOS (ASC:AIM) offers a way to play the continuing shift of retail online while Card Factory (CARD) could benefit as consumers trade down. (JC)


5. FROM QUANTITATIVE EASING TO QUANTITATIVE TIGHTENING: WHAT DOES IT MEAN FOR INVESTORS?

We have been living in an age of extraordinary monetary policy since the 2008 financial crisis but this is now changing. The US Federal Reserve is now tightening its monetary policy and other countries including the UK are expected to follow suit – although the pace of change is unknown.

A stronger economy is normally the catalyst for hiking interest rates and stopping quantitative easing (QE), the term used to describe the way in which central banks have engaged in large scale purchases of (mostly government) bonds to stimulate the economy.

Institutions have sold their bonds to central banks, increasing the money supply in the financial system as the proceeds are used for various activities such as commercial banks financing new loans to encourage more spending and investment.

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Quantitative tightening (QT) is the reverse and is also known as balance sheet normalisation. Under QE, when maturing bonds owned by a central bank mature, they simply reinvested the proceeds into new bonds. When QT begins, the central bank will taper these reinvestments and allow its balance sheet to gradually shrink.

WHAT’S THE TIMETABLE FOR THE UK AND US?

Although the UK has started to raise rates, it has kept QE in place. We wouldn’t be surprised to see growing pressure on the Bank of England during 2018 to provide some guidance as to when it may gradually unwind its programme.

The Federal Reserve started its quantitative tightening in October 2017 and is expected to run the programme until June 2021, contracting its balance sheet by approximately $2tr.

‘The obvious question at this point is: if QE pushed interest rates lower and asset prices higher, why would the opposite not unfold under QT?...and there is the $3.5 trillion question!’ said asset manager Schroders earlier this year.

‘We expect the Fed will have three basic objectives when it comes to unwinding its balance sheet: Don’t crash the bond market; don’t crash the stock market; don’t crash the economy.

‘If the risk of any of these becomes uncomfortably high (most likely brought about by bond yields jumping), the Fed has already hinted that it could either resume reinvestments to stabilise its balance sheet, cut short-term interest rates, or in extremis re-expand the balance sheet through further asset purchases.’

WHEN WILL EUROPE STOP QE?

Investors are keeping a close eye on comment from the European Central Bank (ECB) with regards to its monetary stimulus programme.

The majority of economists in a recent Reuters poll said the ECB should shut the door on its monthly asset purchases next September. Japan’s QE programme is still intact although the pace of its  asset purchases is slowing.

Theoretically QT should be bad for bonds and a headwind for stocks, yet we’re in unchartered territory as unwinding a significant proportion of a large balance sheet without disturbing the economy or markets has never had to be done before. (DS)


6. WHAT SHOULD YOU EXPECT WITH UK POLITICS IN 2018?

An eleventh hour divorce settlement on 8 December paves the way for Brexit talks on a transition agreement and future trading relationship between the UK and EU to begin. Progress on the former, in particular, is likely to be closely followed by investors in 2018.

Another political issue which could have a material market impact are the fortunes of Jeremy Corbyn’s Labour Party.

Corbyn could be a ‘threat’ to big banks and his re-nationalisation policies could clearly be damaging to listed utilities, postal service, telecoms and transportation companies.

A hike in the minimum wage could also impact margins for businesses with large numbers of staff on low pay. Local elections on 3 May 2018 should offer a barometer of Labour’s popularity. (TS)

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7. WHERE ARE THE BIG ELECTIONS IN 2018?

Although unlikely to be as politically fraught as either 2016 or 2017, there are several significant polls taking place next year. The most notable of these elections are in Brazil, Russia and the US.

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The election in Brazil is a risk for investors due to the unpredictability of the outcome amid a tight contest, compared to the Russian presidential election where Vladimir Putin is widely expected to secure re-election.

Brazil managed to escape recession earlier this year but the country is struggling with a wave of corruption.

Whoever wins the presidential election could continue the fight against corruption or stall it. Potential frontrunners include former president Luiz Inácio Lula da Silva, recently convicted of taking bribes himself. He is appealing a prison sentence.

The US mid-term election is significant because it will determine whether the Republicans keep a stronghold in the House of Representatives and the Senate. If the party loses control of either house it would become more difficult for President Donald Trump to pass legislation. (LMJ)


8. WHERE NEXT FOR MAJOR COMMODITY PRICES?

COPPER

Copper prices have rallied in the second half of 2017 thanks to supply disruptions and strong demand. Investment bank Macquarie predicts an almost balanced market in 2018 in terms of supply and demand which suggests we won’t get a repeat of this year’s rally, yet neither does it imply a big sell-off as the New Year progresses.

GOLD

In the absence of a global stock markets correction, war or political turmoil, it is hard to see gold having a good year in 2018 as there isn’t enough panic on the markets to spook investors into buying
so-called ‘safe haven’ assets like gold. Otherwise only higher than expected inflation stands a chance of pushing up the precious metal price.

OIL

The decision by OPEC to extend production cuts from March through to the end of 2018 should provide support for the oil price and should help keep prices above $50 per barrel. Further big advances for crude are likely to be limited as US shale producers boost output, barring a significant escalation of tensions in the Middle East. (DC/TS)

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9. WILL EVERYONE STILL BE TALKING ABOUT ELECTRIC VEHICLES IN 2018? 

The electric vehicle (EV) industry showed rapid development in 2017 thanks to automotive manufacturers giving widespread support and various countries laying out plans to ban diesel cars in the near future.

We believe it will continue to be a dominant theme as investors look to get a slice of the action. That means favourable conditions for engineers, miners, semiconductor experts, and chemical companies with products relevant to the EV industry, although not everyone is guaranteed success.

We expect investors to start to look more closely at individual stocks rather than assuming anyone connected to the sector will benefit.

On the US market, we expect Tesla to come under increasing scrutiny with regards to its cash burn rate and how it sits versus premium car brands which already have an established and broad dealer network. (DC)


10. WHERE NEXT FOR UK HOUSE PRICES?

House price growth is slowing heading into 2018 and it is hard to see that trend changing given higher, albeit slightly, interest rates, pressured household income and an uncertain economic backdrop.

The continuing imbalance between supply and demand is likely to prevent a sharp correction in prices, nonetheless.

Pressure is likely to be greatest on high end London properties with implications for estate agent Foxtons (FOXT) and housebuilder Berkeley (BKG), both of which are focused on the capital.

Jonathan Hopper, managing director of property search consultant Garrington Property Finders, says: ‘Few expect the Chancellor’s stamp duty cut to provide a silver bullet for the misfiring market, and all eyes are now on the Prime Minister to cut a Brexit deal – which might just give the market the shot of clarity and confidence it needs to start 2018 on the front foot.’ (TS)

 

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