Investment Opportunities – How you can benefit from government-engineered growth
Last year was certainly an eventful one, but will 2017 prove to be just as tumultuous? There is undoubtedly a feeling of change in the air with the start of the UK’s Brexit negotiations and a number of elections in Europe likely to play a big part in the direction of the European Union.
It all kicks off with the inauguration of Donald Trump on 20 January as the next US President, so we’re definitely hitting the ground running. This is because both Donald Trump in the US and Theresa May’s UK government are committed to engineering growth and that’s got to be good for the stock markets.
We have identified four related areas where we feel there will be investment opportunities in 2017:
Equities over bonds
A pro-growth environment
Sector rotation from defensives to cyclicals (from toothpaste to trucks)
Equities versus bonds
Politics has become inseparable from investment, and there is now a concerted move from monetary policy controlled by central banks to government-driven fiscal policy. Post the 2008 global financial crisis, monetary policy implemented by central banks has been supportive of both equities and bonds, however given the shift to an emphasis on fiscal policy we are starting to see a divergence between these two asset classes. While fiscal policy is likely to be supportive of equities, bonds could struggle from here given the inflationary consequences. Bonds could be a tricky asset class to invest in an environment of rising interest rates and inflation.
Monetary and fiscal policy – some definitions
Monetary and fiscal policy refer to the two most widely recognised “tools” used to control and influence a country’s economic activity. Monetary policy is primarily concerned with the management of interest rates and the supply of money in circulation, and is typically carried out by central banks. Fiscal policy, on the other hand, is the collective term for the taxation and spending actions of governments.
As a result of this policy shift we may see a more growth-friendly environment, albeit tempered by higher input prices in the shape of oil, higher inflation and modestly higher interest rates. We expect US equities to benefit from President-elect Trump’s anticipated business-friendly, US-first policies. Smaller US companies should outperform their larger counterparts as they tend to be more local and better able to withstand potential import tariffs. Financial companies’ earnings also stand to benefit from broadly higher interest rates. We believe there are a number of funds which could perform well in this pro-growth backdrop in 2017. In the US, Legg Mason IF Royce US Smaller Companies and JPM US Equity Income could well be beneficiaries.
If you’re looking for global exposure, we’d recommend Baillie Gifford International, Veritas Global Equity Income and Artemis Global Income.
- The world’s stock markets have grown every year since 1946 (albeit barely in 2009; the financial crisis)
- They grew before that too – between 1900 and 1946 in all but nine of those years, interrupted by war and financial crises
- Innovation is at the heart of this growth and is continuing at a fast pace
Rotation of performance between sectors
Economic growth tends to follow a pattern that is known as a business or economic cycle. Periods of recession, when the economy contracts, are followed by periods of growth when the economy expands.
Cyclicals and defensives
Cyclical companies tend to perform better during periods of economic expansion. They make goods or deliver services – construction, entertainment, cars, holidays, and so on – that people want to buy when they’re feeling prosperous. Other companies are called ‘defensive.’ They offer goods or services such as food, beverages and personal products that people need regardless of their wealth or economic conditions. Lots of these cyclicals sectors are also termed value stocks, i.e. stocks that are cheap relative to their assets and profit recovery prospects.
Looking at the major equity markets we are currently observing an important trend: sector rotation from defensive to cyclicals. Some sectors are more likely to benefit from the pro-growth environment we are moving into, and it is highly likely sector picking, both by fund managers and individual investors, will be a key success factor when it comes to the stock market outlook for 2017.
Opportunities are likely to present themselves in a number of cyclical sectors such as financials, industrials and energy. We are already starting to see a gradual shift into these areas from more defensive, high yielding parts of the market such as consumer staples and utilities which now look relatively expensive. Despite the shock events of 2016 causing a few short-term flutters in the markets, the long-term investment backdrop remains a positive one. Indeed 2017 looks likely to be a year where there is greater breadth of opportunities across more sectors than we saw in 2016.
The headline number for the major equity indices may not move that much, but we are expecting a broader rally from companies whose shares have rather stagnated over the last few years. Many of the cyclical companies, such as those in the industrials, mining and financials sectors have remained cheap while the market has been led higher by the faster growing technology and consumer discretionary stocks like Amazon, Netflix, Nestle and Colgate. Some of these shares are now trading on high premiums while the cyclical stocks are looking cheap. These are also the areas which should specifically benefit from any infrastructure spend.
Michelle McGrade, chief investment officer of TD Direct Investing, says this move from defensive stocks into cyclicals could mark the start of a rally which extends through the course of 2017. “Value stocks have really recovered. We expect the period of re-rating is mid-way through and the extensive rally will carry through 2017, maybe into 2018 as well. This is an important shift in the leadership of the equity market.”
Sector rotation over the last 10 years
To give some context, let’s have a look at how this type of sector rotation has played out in the past. The chart below looks a bit complicated but bear with us.
What it essentially shows is that a sector can dominate an index (in this case the FTSE All Share) in one year, then can underperform in another. The numbers are percentage return for each sector for each calendar year in sterling terms. This serves as a good reminder to invest for the long term rather than base investment decisions on which sector outperformed or underperformed over, say, a one year period. 2017 may present opportunities that are not obvious based on last year’s sector performance.
Take oil & gas, for example. Over the last decade it has generally been towards the lower end of sectors in terms of performance, but in 2016 it was the second best performing sector
Technology, on the other hand, has often been one of the better performing sectors, although it suffered during 2008, the year of the Global Financial Crisis. Similar fluctuations can be seen with financials
This rotation between different sectors and different styles of companies is common across all indices
Past performance is not a reliable indicator of future returns
We have observed that value companies which mostly fall into the cyclical sectors have outperformed their growth counterparts over the course 2016. Evidence shows value outperforms growth over the very long term.
A number of value funds would seem to offer the best upside potential. We have selected a number of UK funds which we believe could deliver strong performance in 2017. These include JOHCM UK Dynamic, Man GLG Undervalued Assets, Majedie UK Equity, Old Mutual UK Alpha and Investec UK Special Situations.
Investec UK Special Situations manager Alastair Mundy says equity market volatility should present interesting options for investors. “In absolute terms, cheap stocks are relatively hard to find in the UK, as valuations remain significantly above long-term averages. Despite this, we are finding attractive opportunities in the banking and food retailing sectors.”
Spending on infrastructure has been specifically mentioned by both Trump and Chancellor Phillip Hammond. For more on the opportunities in infrastructure please read this article which we wrote in December. We believe the best way to gain exposure to the increased infrastructure spend is by investing in a broad range of sectors rather than focusing on pure infrastructure plays. Funds such as First State Global Listed Infrastructure, while remaining solid investments, may not immediately benefit from the new Government spend. Exchange Traded Funds (ETFs) focusing on these areas may therefore be a better option.
Within this area, we expect to see disruption playing a key role in the delivery of infrastructure projects as innovation continues to shape our modern society. Disruptive technology is driving change and ultimately spurring global growth. If you want to buy into the disruptive technology story, Henderson Global Technology is investing in some innovative, leading edge themes such as the proliferation of cloud computing.
Potential risks to look out for
Political uncertainty could also lead to some headwinds, with a number of European elections in 2017 and an outside chance that the rise of populism could lead to a European Union breakup. Questions over the nature of international trade agreements, combined with Trump’s “irregular” methods of communication, are likely to produce a degree of uncertainty.
Rising inflation, oil prices and interest rates could create issues if they get out of control, but we believe they are more likely to rise to manageable levels. And currency moves could be a concern for UK investors investing abroad as the value of sterling is pulled around by sentiment rather than fundamentals.
While the outlook looks fairly bright, predicting the exact movements of stock markets is never easy. As ever, diversification is key and time in the markets, rather than trying to time them, is a mantra worth repeating.
Remember each fund is unique and exposed to different levels of risk. Some are relatively low risk, whilst others can be very risky and those will only be appropriate for more sophisticated investors.
The information we provide in this Investment Outlook are opinions provided by TD Direct Investing or one of its partners on whether to buy a specific investment. None of the opinions we provide are a personal recommendation.
Investors should be aware that the value of investments can fall as well as rise, you may get back less than you invested. Past performance is not a reliable indicator of future returns. If you are unsure about the suitability of a particular investment you should speak to a suitably qualified financial adviser.