2017 was another year of political shenanigans, from the ill-advised UK election, continued uncertainty related to Brexit, and Trump’s squabbles with almost everyone (both sides of Congress, North Korea, and others). These headlines generated a lot of noise, but with hindsight it is clear that there was very little change of any significance.
However, from an economic point of view, 2017 was significant because it finally became clear that the global economy had recovered from the effects of the Global Financial Crisis, which began over a decade ago.
The effects of the credit crunch dominated global economics and government policies for the majority of the last ten years. Central banks across the world supported the financial system via massive levels of Quantitative Easing (QE), and interest rates have been at record lows for far longer than could have ever have been expected before the crisis.
For most of the decade, growth around the world has been sporadic, unsynchronised, and generally low. However, the global financial system has now mostly dealt with the effects of the credit crunch, and the major countries of the world are growing healthily in lock-step. After so many years in the doldrums, it is hard to overstate the positive effects of a return to growth.
This positive outlook may help to explain why equity markets have continued to rise over the last few years, and why volatility (often an indicator of investor anxiety) fell to record low levels in October. The optimism must be tempered, however, by the knowledge that equity markets have risen to relatively expensive levels. In addition, QE is being gradually withdrawn, and interest rates are likely to continue to rise as inflationary pressures return to a more ‘normal’ level.
As ever, experience tells us not to stare into the crystal ball and make predictions about the global economy or stock markets in 2018. However, economic conditions are supportive, and the reflationary cycle is likely to be positive for equity markets.
Moreover, multi-national companies will continue to benefit from sources of revenue growth around the globe, such as the expanding middle class in countries such as China and India. These are strong, multi-decade trends, and well positioned companies can grow their revenues year after year at rates which would be considered unachievable in a mature economy. In addition, technological developments will allow innovative companies to reduce costs continually over the next decade, whether by automation or artificial intelligence.
The key to a successful long-term investment strategy is to manage risk across the market cycle in a wide range of environments. Our investment ethos can be defined as a ‘value & quality’ strategy. This strategy means that we prefer companies with strong balance sheets, strong cash flow generation and higher dividends, alongside other factors such as a clear competitive advantage. Studies show that this strategy outperforms in the long run, but should also outperform at this stage in the cycle. Companies with low levels of borrowing (‘unleveraged’ balance sheets) perform well during periods of rising interest rates, given that higher interest costs have a proportionately smaller impact on them relative to leveraged companies.
The bull market we have experienced for the last few years cannot last forever, but, for the above reasons, we are well positioned for current market conditions, and we are cautiously optimistic for 2018.
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