2017: the start of a new cycle?

Rates are going to rise and we’re going to see inflation. When was the last time you heard those two predictions at the start of an annual outlook? Perhaps a few fund managers were willing to put their heads above the parapet in 2016, but political uncertainty put paid to any major improvements in the global growth outlook.

2017, however, seems to be a different kettle of fish. Last we heard from the International Monetary Fund, global economic growth was expected to tick up to 3.4% in 2017, from 3.1% in 2016. America raised interest rates in December and hinted at further rises throughout the year, which is a sign the US Federal Reserve thinks the economy is in much better shape than it’s been for a while.

Bond yields are also starting to rise. Bond yields are often used as a gauge of global sentiment and can give clues as to where both bond and equity markets are likely to head. Falling yields equals rising bond prices and can indicate people are concerned about economic growth prospects and expect interest rates to also fall. Rising yields means falling prices and typically suggests people are more positive on the growth outlook.

So for the first time in around 35 years, 2017 may see us investing in a period of rising rates and bond yields, and inflation. It’s not that rates are going to be high—I mean, we’re starting from a low base; the US is still only at 0.50% to 0.75% and the UK is at 0.25%—but the important thing is we could be entering a new cycle.

Similarly, inflation (price growth) has been minimal or non-existent around the world for several years now. Most central banks in developed countries consider a healthy economy needs somewhere between 2% to 3% inflation annually, yet many have struggled to get their rate above 1%. So even small improvements would be welcome.

These changes could definitely have impacts on how and where you invest your money.

Where to put your money?

So what are we expecting in three key markets to in 2017? Here’s a quick round-up:

• UK equities: Returns were driven by the falling pound in 2016, which boosted revenues earned oversea by many of our largest companies. This year has got off to a good start with record highs in the UK stock market, but at some point we are going to have to deal with Brexit, so I advocate some caution if you’re buying into the market at these levels. In terms of stocks, a rising rate/inflationary environment suggests cyclical companies and value stocks may do best. Two excellent value-driven funds, which were among the top UK equity fund performers in 2016, are the Elite Rated Schroder Recovery and R&M UK Equity Long-Term Recovery.
• European equities: At an investment outlook this week, Alister Hibbert, manager of our Elite Rated BlackRock European Dynamic fund, said for the first time in a long time Europe had become an underweight in many portfolios. “Europe looks okay”, he said, “but I don’t think its time has come.” Alister noted the significant divergence between the US’s central bank (i.e. raising rates) and Europe’s central bank, which is unlikely to reverse its negative rate, economic stimulus program any time soon. European company earnings are flat to down over the past five years or so, and Italy’s banks are a real concern. Politics are still very much at the fore in 2017, with national elections in France, Germany and the Netherlands. Nevertheless, Alister emphasises there are plenty of good companies despite broader challenges in the economy and said good active managers should find opportunities.
• US equities: While I am minded to be cautious in the US market right now—like the UK, its stocks are at record highs and look pretty expensive—Trump’s election and his desire to lower corporate taxes has many forecasting higher company earnings. This could obviously give the S&P 500 yet another growth spurt. On the other hand, I’d stress there’s absolutely no certainty this action will go ahead and, more broadly, most of Trump’s plans look pretty unclear at this point. If value stocks do well in a rising rate environment, a fund like the Elite Rated Brown Advisory US Flexible Equity could be a good pick. It has a value bias but will look for growth stocks too, and this style diversification makes it a good either-way candidate.