Wednesday, February 8, 2017
Insights from our quarterly investment review
Taking stock after a year of 'surprises'.
World stock markets had a bumpy 2016. Most fell by about 10% at the start of the year before recovering, and then ended the year strongly. In between, the small matters of the Brexit referendum and the US presidential elections. But yesterday the Dow Jones Industrial Average (in the US) hit a new all-time high.
Independent investment economist Peter Stanyer comments:
'The major shocks for pundits and markets in 2016 were the Brexit decision and the election of Donald Trump as president of the USA. Both of these had been seen by most commentators as unlikely to happen. If they had been forecast, most would have expected an adverse reaction from markets.
'In the short term, one has to conclude the experts were wrong on both counts.'
You can read Peter's thoughts on the impact of President Trump here: Peering through a glass darkly
So, performance in 2016 was generally very good. This is shown in the chart below:
The coloured vertical bars show our best estimate of the likely range of returns from each major asset class (per year). The horizontal white bar is our estimate of the average long term return. The diamond shows the actual returns experienced over the last 12 months (before tax and costs). Please note that past performance is no guarantee of future returns.
The returns from bonds and shares were at the top end of our expectations. These are the two asset classes which make up most of our recommended portfolios. The effect is that most FPC clients will have seen strong double-digit returns last year – always pleasing, as it means goals are more likely to be achieved.
We still don’t know quite what Brexit will mean for the UK economy; nor can we be sure what impact President Trump will have on global markets.
For example, a recent article in the Economist discussed Trump’s plan to cut corporate tax rates – suggesting this could be 'paid for' (at least in part) by stopping companies deducting interest expenses from their taxable income. This would be a big change and highly-indebted companies would probably suffer as a result. But stronger firms would likely benefit.
Meanwhile BP announced this week it needed oil prices to climb to $60 a barrel to cover current cash flows. A year ago the oil price was just $30 a barrel and three years ago it was $100. At the moment it’s around $50-55 – bad news for BP, but good for airlines (and motorists).
Uncertainty is high. But stock market volatility, as measured by the VIX index, is remarkably low. When stock market volatility increases, credit spreads also tend to widen. This means there could be rocky times ahead, both for bonds (especially 'high-yield' bonds) and shares.
What should you do?
If there's one lesson to be learned from 2016 it's that short-term predictions (even for the 'experts') are very difficult to make – and harder to profit from. This is why we avoid trying to time markets, and instead focus on the long term.
Our approach is to get the big decisions right and focus on what you can control.
- Holding cash, so you don't need to sell investments if markets do fall (in the short term)
- Investing in the right blend of ‘growth’ and ‘defensive’ assets – with appropriate diversification
- Keeping costs and taxes low
As Sir John Templeton said: The four most expensive words in the English language are "this time it's different."