The fall in sterling turned 2016 from a difficult year for UK-based investors into a good one, but with sterling more likely to appreciate in 2017 than weaken further, that tailwind is no longer blowing. A good performance from equities in 2017 will require either earnings growth or stocks to trade on a higher valuation. Neither is a given.
Investment analysts are forecasting double-digit earnings growth for next year, but those forecasts are usually relentlessly downgraded over the year. A re-rating of equities onto higher valuations would normally require either an excess of investor enthusiasm, which looks unlikely, or lower bond yields. Instead, the predictable crash in bond markets looks likely to continue.
Bond investors have, at last, lost confidence in central bankers and woken up to the reality that ultra-low bond yields are encouraging a borrow-and-spend binge by governments. Higher bond yields should give politicians second thoughts, but this is unlikely until central banks have responded with higher interest rates and, probably, an economic slowdown has been set in motion.
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But not all is gloom. Stocks have held up well in the face of rising bond yields and should move ahead when yields flatten out in 2017. Earnings will be helped by a rebound in the energy sector, and there are bright spots elsewhere. Patient investors who are prepared to take a bit of risk should be well rewarded.
After four dismal years, the performance of emerging markets turned around in 2016, although the recovery suffered a setback when Trump's election boosted the dollar. But the dollar is far from the sole determinant of the fortunes of emerging markets. Undervalued currencies, higher resource prices, more market-orientated governments, sounder finances and steady growth are all supportive, added to which firms are prospering and reasonably valued.
Larger generalist emerging markets investment trusts, such as those run by Genesis (LSE: GSS), Templeton (LSE: TEM) and JP Morgan (LSE: JMG), all look good value on discounts to net asset value (NAV) of 12%-13%, while there is no shortage of high-quality specialised trusts for the more adventurous.
The threat to the healthcare sector that would have been posed by Hillary Clinton as US president has disappeared though the consequences for the higher-quality, innovation-led firms were always exaggerated. The discounts to NAV at which the shares of Worldwide Healthcare Trust (LSE: WWH) and Biotech Growth Trust (LSE: BIOG) trade have fallen, but the long-term growth outlook is intact and the valuations of portfolio companies are very reasonable.
The performance of medium-sized and smaller companies in the UK has been disappointing lately they have failed to outperform the FTSE 100 this year. The FTSE generates a larger share of profits directly from overseas than mid-sized and smaller companies, and so has benefited more from sterling's weakness.
However, the long-term trend for smaller companies to outperform larger ones, which also applies internationally, looks set to continue. The small-cap trusts managed by Aberforth (LSE: ASL), BlackRock (LSE: BRSC), Henderson (LSE: HSL) and JPMorgan (LSE: JMI) are all high quality, but trade on discounts of 15%-20%, while Strategic Equity Capital (LSE: SEC) is less cheap.
The safest prediction for 2017 is that patient investment in funds run by managers focused on long-term stock selection will do far better than active investment reacting to world events and economic grandstanding.
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Max has an Economics degree from the University of Cambridge and is a chartered accountant. He worked at Investec Asset Management for 12 years, managing multi-asset funds investing in internally and externally managed funds, including investment trusts. This included a fund of investment trusts which grew to £120m+. Max has managed ten investment trusts (winning many awards) and sat on the boards of three trusts – two directorships are still active.
After 39 years in financial services, including 30 as a professional fund manager, Max took semi-retirement in 2017. Max has been a MoneyWeek columnist since 2016 writing about investment funds and more generally on markets online, plus occasional opinion pieces. He also writes for the Investment Trust Handbook each year and has contributed to The Daily Telegraph and other publications. See here for details of current investments held by Max.
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