After a decent year in equity markets, will the good times last ? Market Outlook – January 2017

Somewhat against the odds, 2016 has turned out to be quite a good year for equity investors. I say ‘against the odds’ because global stock markets endured their worst start to a year on record.

Market outlook

The FTSE All Share Index and the S&P 500 both lost 9 per cent during the first six weeks of the year. From that low point in mid-February the All Share rallied 25 per cent to make a new all-time-high in October. It then fell back in November but has put in a good end to the year and a firm start to 2017.

The FTSE 100 Index of large companies has performed well, helped by a rebound at long last in the major oil and mining stocks. We aren’t back to boom times but it does look like the commodity cycle has turned with oil doubling from its low point of $28 hit early in the year. Small caps have done a decent job of keeping up and the AIM Index chart looks very encouraging.

A lack of euphoria

Yet few of us are dancing in the streets! It’s been a far from easy ride despite those headline returns. The surprise referendum result at the end of June caused some frayed nerves as the market plunged in shock. We had been told by the Chancellor and the Governor of the Bank of England to expect economic armageddon in the wake of a Leave vote. It didn’t turn out that way.

The stock market sorted itself out in a matter of days and resumed its rise. The UK economy responded by generating some robust data, which led to upgraded growth forecasts rather than the doom and destruction promised.

Even so there’s still a fairly dense mist obscuring next year’s outlook, which is keeping the lid on any inclinations to celebrate. But there are several sources of encouragement out there.

One of these factors is sterling’s devaluation in the second half of the year. That will provide many companies in our open economy with a tailwind. Exporters are more competitive, imports are less attractive than domestically produced goods and overseas earnings are boosted when translated into sterling.

New broom

Another positive element has been the improving sentiment in the US. Mr Trump’s victory was supposed to have the same devastating effect on stocks as the Leave vote, but the pundits were wrong here too. The S&P 500 has made a decisive all-time high and has good momentum. That augurs well. There’s a sense that a radical new broom with innovative policies could shake the US and world economy out of the rut that it’s been stuck in since the initial recovery from the financial crisis.

US bond yields are rising from very low levels and interest rates have started the journey back to to normality. We might have to wait a bit longer for that to happen over here. But with the economy holding up well, the new Chancellor talking about fiscal expansion, and with both wages and inflation heading upwards, we could see the same trend take root in the UK. That would be another signal that the economy is becoming more robust.

Casting off the shackles

I’m keen to look for these supportive factors because I believe the market has scope to do really well if it can cast off the shackles of doubt that have held it in check for so long now.

It’s not hard to find many small cap stocks on modest p/e’s and attractive yields that could easily be rerated if sentiment brightened. And if we were to see the start of the ‘great rebalancing’ from bonds back into equities, then the sky would be the limit.         

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