January 2, 2018

Pegler’s market report – 02.01.18: Year End Review 2017 – The Long Cycle Continues

As published in the Brighton Argus (02.01.18) Business section under the title Pegler’s Market Report:

Year End Review 2017 – The Long Cycle Continues

After another excellent year for investors, we take this opportunity to once again reflect on the period and look ahead to 2018.

The theme which unfolded during 2017 was one of global reflation, with above trend economic growth helping companies to deliver on earnings. Steady global growth, robust trade and a recovery in commodity prices have combined, driving risk assets higher, particularly equities. All major regions increased earnings at a faster rate than expected, delivering the strongest growth since the post-crisis bounce.

Many commentators still view the synchronised global expansion as having room to run in 2018 and potentially beyond, although a note of caution should be sounded, with fuller valuations across assets, 2017 will be a tough act to follow.

With the revival in global growth, Europe, Asia, Emerging Markets and Japan seem to be well-placed to lead further gains. Despite appearing relatively expensive, it is also difficult to bet against the US, which has consistently offered the most attractive fundamentals. US tax cuts could boost near-term growth and quicken the Federal Reserve’s pace of interest rate normalisation.

The UK of course remains a special case, with Brexit negotiations likely to continue to dominate the outlook for UK assets. The index of 100 leading shares was a notable laggard last year, unwinding some of its outperformance from 2016. Sterling has made a fairly decent recovery, against the US Dollar at least, taking the shine off the large proportion of earnings generated overseas. The rally in Sterling is perhaps an indication of the recent progress in Brexit negotiations, but in large part also due to Dollar weakness.

Many investors have remained sceptical of the current bull market cycle, preferring to focus on a broad and varied selection of macro-risks. Whilst many in the financial industry continue to recognise these, such global reverberations are typically short lived when the economy is on a strong footing.

Valuation remains one of the principal concerns, where on historical comparison, many growth assets and some more defensive assets are expensive. This warrants increasing caution, because higher valuations point to lower returns over the long-term. Having said that, valuation alone has tended to be a poor short to medium term indicator.

Despite the length of the current cycle, it is said that bull markets do not die of old age, rather they tend to decline ahead of an economic downturn and after prolonged periods of tightening by central banks. Neither of which appear to be on the short-term horizon and although this cycle may be closer to its end than its beginning, investor scepticism tends to give way to euphoria during this later stage and it may be this which serves to drive equity markets higher again in the year ahead.

By David Pegler, Brighton Capital Management