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Investing through disruption

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From technological innovation to economic growth, our 2018 investment outlook uncovers the forces that will drive the world economy this year and beyond

15 min read

2017 has been another excellent year for clients who have invested with Coutts. While markets have been supportive, it has been our decision to retain a preference for equities alongside our investment themes that have generated strong performance compared to peers and relative to the markets.

As we look ahead to 2018, we continue to see value in our investment themes but also recognise the economic landscape is changing. This will bring challenges but our investment principles and in-depth research means we are well placed to navigate markets and identify fresh opportunities as they arise.

In this year’s outlook, we review the latest market trends and what this means for investors for 2018. As long-term investors, we also see the need to look beyond the current environment to the structural shifts emerging around the world that will influence the global landscape in the decades to come. We see changes in global trade, technological innovation and government policies as three key areas that when combined have the potential to fuel significant change through the rise of inequality.

“We see changes in global trade, technological innovation and government policies as three key areas that, when combined, have the potential to fuel significant change ”
Mohammad Kamal Syed, Managing Director, Coutts
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Looking ahead to a year of slower growth

Whatever the year may bring, our aim is to continue to protect and grow our clients wealth. With inflationary pressures building and a flex point looming in the economic cycle, it has never been more important to plan carefully how you will protect your spending power both for yourself and for your family.

To find out more about your investment options with Coutts contact your private banker or contact me directly on MohammadKamal.Syed@coutts.com.

 

Mohammad Kamal Syed

Managing Director, Coutts

  • CHAPTER 01

    Looking back on our 2017 investment opportunities

    In our 2017 Investment Outlook, we highlighted seven investment opportunities identified through our in-house research that we believed offered particularly attractive long term prospects. We are now in a position to reflect on how these opportunities have performed and consider whether the value we identified at the beginning of the year has begun to materialise.

    We are pleased to report that the average return so far from all of the opportunities is 11.6%*, compared to a general market return of 8.7% (based on 50% UK equities, 50% gilts) over the same period. Six of the seven have made money, and only short-dated bonds are (slightly) down.


    "If it ain’t broke, don’t fix it"

    We retain conviction in all seven of our 2017 opportunities and believe they have an ongoing role to play in our portfolios and funds, at least for the time being. The ongoing world economic expansion and signs of inflation picking up in the major markets this year should support these trades in the next 6-12 months.

    Where do we have most conviction?

    • Sterling - The pound still looks attractive by long-term standards, and remains at the low end of its 40-year valuation range. We expect it to recover further against major currencies, especially if the UK trade deficit begins to fall – which should begin soon, in our view, provided the Brexit negotiations are not too prolonged.
    • Global Healthcare - The sector remains inexpensive by long-term standards and continues to deliver healthy earnings growth, which investors haven’t yet appreciated fully. We think pharmaceutical and biotech companies should benefit from long-run demographic trends, with older people across the world increasingly prepared to spend heavily to live healthier lives.
    • Alternatives - Diverse alternative investment strategies, ranging from trend-following to market neutral to global macro, still look attractive and provide ballast within portfolios, helping to offset some of the risk that come from equities.

    *to 7 November 2017, equally weighted across all 7 opportunities 

  • CHAPTER 2

    5 challenges expected in 2018

    Global growth – is there a slowdown and how should investors navigate it?

    Most of the major economies have picked up in the last year, including the US and Japan, with the International Monetary Fund (IMF) forecasting world growth to have reached 3.6% in 2017. But we think the global manufacturing cycle is peaking about now, which raises the question: what next for the world economy and where to find value for investors?

    With robust consumer and investment demand, low inflation and accommodative monetary policy in most countries, we are expecting the looming slowdown to be gradual, with world growth as a whole still firm through 2018. With company earnings in the major markets likely to continue rising and no sign of US recession on the horizon, we continue to have confidence in equities, with a bias towards those regions where we see the growth cycle persisting for longer, like Europe and Japan.

    Inflation down but not out – can investors avoid their wealth being eroded?

    Over the last two years inflation worldwide has surprised on the downside – partly because oil prices plummeted in 2014-15, partly because wage pressures have been subdued. In the next 12 months we expect inflation to bounce a little in the US and Europe, while in the UK it has so far peaked at just over 3% (to October 2017.

    |nvestors who hold cash will find their wealth being steadily eroded, since cash and government bonds in most developed economies, including the UK, yield less than inflation. Many investors who spend on luxury goods and services will be particularly hit. The Coutts Luxury Price Index shows that prices increases for luxury items often exceed that of the standard rate covered by the Consumer Price Index with categories like communication and transport increasing considerably more.

    In our search for inflation-beating returns we favour segments of higher-yielding bonds, like financial credit (yielding over 5%) and emerging market debt, and equities, where dividend yields are solid (4.2% for the UK’s FTSE 100) and earnings are growing.

    A turning point for Japan?

    The Japanese economy has been stuck in a deflationary mire for many years, but may be escaping at last. By the third quarter of 2017, after seven quarters of growth, the economy was enjoying its longest period of expansion since 2005. Both private consumption and exports have been growing strongly and the Tokyo Olympics looming in 2020 are likely to support the investment outlook over the next two years as infrastructure and related spending are expected to boost the economy by up to 1% of gross domestic product (GDP).

    We expect the re-elected government of Shinzo Abe to continue its reform program, while the Bank of Japan will maintain monetary policies that are helpful for companies and the financial markets. These factors underpin our view that Japan’s prospects are normalising and that the outlook for Japanese equities is positive. In our view, corporate balance sheets are healthy and equity valuations look attractive compared to other major markets.

    Equity valuations: are we at a cliff edge?

    According to a recent survey of global investors, a record number of asset managers believe global equities are expensive, with the US market cited as the most overvalued by 80% of respondents.  Many traditional measures used to value equities indicate that valuations are on the high side, with some in the US more than double their historical norms.

    Since high valuations are associated with lower future returns, this underscores the importance of identifying areas of the market that are undervalued by investors, consistent with our investment beliefs. Our detailed and wide-ranging analysis indicates that these areas can be found – as reflected in our regional themes (e.g. Europe and Japan) and sectoral choices (technology and healthcare). Valuation multiples for these areas remain below the rest of the market or are in line with or below their historical averages.

    Emerging markets – is the political and economic complexity worth it?

    2017 has been a strong year for emerging market equities and bonds, helped by the weaker US dollar (emerging market assets are typically priced in dollars and usually rise as the dollar weakens). Many of the risks identified by commentators in 2016 did not materialize, such as President Trump’s threatened trade restrictions or rising debt levels in China leading to a financial crisis. In our view this is typical of emerging markets, with the political complexity rarely influencing long-term returns - we see global trade as a far better barometer of their economic health and investment opportunities.

  • CHAPTER 03

    the global wealth challenge 

    As long-term investors we recognise the need to look beyond the next year or two. Economic trends across the world and structural changes in society will influence how the global economy functions in the decades to come, and fall firmly within the scope of our investment research. One trend we see that could have a profound effect on the world is the growing gap in developed countries between the wealthiest and the poorest people. A combination of technological change and globalised trade has lowered the demand for less skilled workers in the developed countries and squeezed their earnings, particularly in manufacturing.

    By contrast, more highly skilled – and typically higher paid – occupations have fared better. Changes in employment patterns have magnified the effects of these inequalities. Developed economies have moved away from settled ‘jobs for life’ to working patterns that entail shorter tenures at more employers. At the same time, defined benefit or ‘final salary’ pension schemes gradually became unaffordable and have been closing down, making workers more responsible for funding and managing their retirement. As jobs become more fragmented, people move around more and live for longer, questions arise about whether they will be able to afford to retire. Again, this trend favours highly skilled workers who have the ability to assess the best pension options and have the earning capacity to put aside large amounts for the future.

    In our view, understanding these long term trends is essential to the management of wealth across generations. It also helps to inform our investment thinking, giving us a range of ideas to explore.

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