Richard Stone, outlines three things that he believes could happen in 2018 and explains how investors can position themselves.
The main political focus of 2018 will be the Brexit negotiations. This is likely to be a rollercoaster ride as the difficult issues come into sharp focus. Reaching an agreed position on a handful of issues ahead of ‘Phase 2’ was hard and this will be harder. However, there does seem to be an element of ‘kicking the can down the road’ as there is agreement on a transition period to at least 31 December 2020 and the trade deal we do with the EU will not be agreed until we are in that transition period. The next phase of discussions will be keenly focused on what that transition period looks like.
There is a need to finalise the withdrawal agreement by October 2018 in order to allow sufficient time for it to be considered by European Parliaments and the UK Parliament. I believe the greatest risk of ‘no deal’ comes from the prospect of one (or more) of those 27 national parliaments within the EU deciding not to agree to the terms. This could scupper the whole deal – just as the Belgian province Wallonia stalled the long worked on EU-Canada trade deal.
I believe pragmatism will win out and there will be a deal – a real ‘no deal’ scenario cannot happen due to the need to agree matters of security, aviation etc. The question is how pared down the deal has to be to get an agreement and, beyond those critical items, what happens to other aspects of the relationship if they are excluded due to a lack of alignment.
The mood music from the negotiations will be critical. This will be playing against the backdrop of an unstable UK political landscape. Remainers and Brexiteers will both be unhappy at aspects of the negotiations. The Government will face challenges in the House of Commons and in the House of Lords. The Prime Minister is walking a tightrope and it is conceivable that the UK Government may fall at some point during the process.
I believe inflation will remain stubbornly higher than expected during 2018. While the one-off effects of the devaluation of Sterling following the EU referendum may have largely worked their way through the system I believe the low level of unemployment combined with a slowdown in migration and the continuing impacts of quantitative easing and low interest rates will start to feed through into inflation. This will be felt in demands for higher wages, fuelled in part by the Government’s decision to relax the public sector pay cap a move which is recognition that the squeeze on wages cannot continue indefinitely in the face of higher inflation.
Linking back to politics, any newsflow suggesting difficulties in the Brexit negotiations – of which there will inevitably be plenty based on the experience to date – could drive Sterling lower, in turn adding to inflation. Oil prices – in dollar terms – have risen over 40% in the last six months and have been on a steady rising trajectory since July. This too will fuel inflation.
If inflation remains stubbornly high the demands for higher wages may not be sufficient to drive a return to real wage growth. Personal investors will continue to see their incomes, standard of living and ability to add to any savings and investments, further squeezed. This will not be helped by the Bank of England’s likely response of a further increase in interest rates during 2018. It will be important to see the tone of the Governor of the Bank of England’s letter to the Chancellor, written following the increase in inflation above 3%, when it is published in February.
The FTSE 100 closed 2016 at a record high and did the same in 2017. Many commentators have, for some time, been talking about the prospect of a correction in the markets, when it might come, what the trigger might be and how bad any correction might be.
I believe 2018 will see the markets being more volatile than they have been in recent times. The VIX Index (a measure of market volatility primarily looking at the US market) is close to record lows not seen since early 2007. This is in contrast to the fact that the world feels a more uncertain place – to me at least – than it has done previously. This manifests itself in concerns over many geo-political issues such as North Korea, Brexit and the impact of a resurgent Russia.
Markets are though driven by supply and demand. At the moment the forces of demand are winning the day and driving equity prices higher. I believe this is likely to continue and could drive the FTSE 100 index above 8,000 for the first time in the Index’s history – albeit I am not saying the index will necessarily end 2018 on yet another record high as I do believe that volatility will increase substantially in 2018.
The main drivers of demand which will continue to support the market to higher levels – in the absence of any of those geo-political concerns crystallising – are improving global growth, continued accommodative monetary policy (and in the US fiscal policy) and increased corporate merger activity (we have seen a number of major deals announced at the end of 2017, e.g. Disney and Fox, Ladbrokes and GVC). There are other factors in the UK specifically which will also help drive demand for equities. Most notably this includes the more than doubling (from 2% to 5%) of the minimum contribution required to be made into auto-enrolment pension schemes. This takes effect in April 2018.
I remain optimistic about the outlook for the UK and for the UK economy. The devaluation of Sterling has increased inflation and hit real wage growth, but it is boosting exporters and with global growth now improving the UK should benefit. I therefore think the UK will outperform the current consensus growth forecasts for 2018 of around 1.4%.
Deciding where to invest is challenging in an environment of increased political uncertainty and potentially increased market volatility. However, in the near term the drivers of demand for equities remain strong and the FTSE 100 could be driven through the 8,000 level for the first time. As always, it is important that investors take a long term view when investing. Investing a little and often helps overcome some of the challenges higher volatility presents as well as enabling investing when there is less disposable income to put to one side in lump sums. Normally, defensive sectors such as utilities can provide some relief in more volatile times, and may help investors looking for income, although now investors should be wary of the political threat of renationalisation should the UK Government change.
If interest rates rise further in 2018 and beyond that rise quicker than is currently expected, investors should look for companies which will benefit from increasing interest rates. E.g. those which hold significant sums of cash as compared to those financed through debt. Investors bold enough to pick specific equities may want to try and identify those sectors likely to be subject to consolidation, or sectors where consolidation has created a large player which in turn may drive others to consolidate. For example, how will the energy sector react to SSE and Npower merging, or the gaming sector respond to Ladbrokes acquisition by GVC?
2018 promises to be an exciting year and a potential rollercoaster for personal investors. In short, hold on to your hats, it may be a bumpier ride than in 2017, but there will be opportunities for personal investors and ultimately the markets should continue to reflect the benefits of increasing global growth and continued relatively accommodating monetary and fiscal policy.
These views are those of the author alone and do not necessarily reflect reflect the view of The Share Centre, its officers and employees