INVESTMENT LINE: MARKET UPDATE - DECEMBER 2017

However clichéd it may seem, this is inevitably the time of year when we look forward to what the coming twelve months might bring. The returns enjoyed by portfolios have been much more generous in 2017 than many had expected, and some of the euphoria in the months following Trump’s election has returned as the year comes to a close. We have remained fully engaged and invested whilst at the same time exercising the caution that we feel any responsible investment manager must do in this environment. Valuations have continued to become ever richer, and the markets have remained almost dismissive of political risk and managed to overcome several expected obstacles. The result is an environment of extreme complacency, though the usual fear and greed are still in attendance. No one wants to miss out on returns, but can another ‘too good to be true’ year really be ahead?

We can envisage two different scenarios for next year – first, a benign one in which markets continue to smoothly ascend, and the other a more negative one in which the risks about which we have been warning finally transpire. How might the first come to pass? Well, if the US tax cuts are swiftly implemented and the political risk around the impeachment of Trump dissipates, this would certainly be helpful. A smooth unwind of the Federal Reserve balance sheet and a controlled slowdown in China would be further good news. Continued steady global growth with limited accompanying inflation coupled with a market friendly outcome in the Italian General Election would be the icing on the cake. This could lead to the sort of euphoric ‘melt-up’ in asset prices that we often see at the end of a bull market. And what of the look of the converse scenario? Presumably pretty much the opposite of the positive one just highlighted – the US moving closer to recession, a threat to asset prices from the unwind of the Federal Reserve balance sheet, political events in Europe, contamination from the nascent deleveraging in China and even the manifestation of geopolitical risks. Markets will find themselves in fundamentally different positions at the end of 2018 depending on which of these scenarios transpires. As always, the number of permutations of unknown events is almost endless, but for now the majority of investors seem to be betting that central banks will continue to provide market friendly policy support in the face of a multitude of potential challenges.

These outlined scenarios are hypothetical, extreme ones and the reality will surely fall somewhere in the middle. Our approach has been and remains to construct portfolios that can cope with a range of outcomes, containing volatility and trying to identify value in a world of distorted risk and return. We have managed to keep pace with our benchmarks despite adopting a cautious approach in a strong year for global equities, and this is extremely encouraging. Part of this is a reflection of our doing things differently and focusing on select opportunities outside the usual geographic-oriented asset allocation framework. At some point we anticipate that a yet more cautionary tone might need to be adopted, but for now positioning looks appropriate. Vigilance will remain a key attribute and when market complacency eventually wears thin, the creativity to make the right strategic changes will prove a major performance differentiator.