What Impact Would Political Bluster Have On Investor Sentiment In 2018?

In Sir Arthur Conan Doyle's 1892 book The Memoirs of Sherlock Holmes, the famous detective solves the mystery of a disappearing racehorse by focusing on 'the dog that didn't bark'. Holmes understood that a watchdog which remains silent as a stolen horse is led away must know the thief. Simple.

Investors seeking to understand the stellar performance of global stock markets in 2017 should probably also focus on what didn't happen last year. And, more usefully, they might think about which if any of these non-events might come to pass in 2018. The dog may not have barked last year; this year it might.

The first thing that didn't happen last year was a recession. This was most likely in the UK, where pessimists have forecast ever since the EU referendum in 2016 that the British economy is about to fall off a cliff.

Growth certainly slowed last year, and the UK fell from the top of the developed world's growth table to the bottom, but growth remained positive and is expected to do so this year and next.

Growth in China also held up better than feared and the extended US upswing continued unchecked. The global economic upturn is looking increasingly synchronised. Bear markets rarely begin in the absence of a recession, or at the very least the reasonable fear of an imminent downturn, so the long haul out of the financial crisis should continue to support equities this year.

Something else that was feared by investors but failed to show up was a trade war between the US and China. President Donald Trump's bark turned out to be worse than his bite in his first year in the White House.

Yes, he pulled out of the Trans Pacific Partnership but his campaign talk about branding China a currency manipulator was more bluster than a real economic strategy. In that, it was similar to the Great Wall along the Mexican border that was good Twitter fodder but came to naught. Looking into 2018, the chance of these grand-standing measures coming to fruition must surely diminish as the Mid-Term elections approach.

Politics was the third non-barking dog in 2017. At the start of the year, the resurgence of Europe's Right Wing was one of investors' greatest fears. The prospect of Marine Le Pen in the Elysee Palace spooked investors.

Unsurprising, then, that as mainstream candidates prevailed in election after election, European market sentiment picked up steadily. Going into 2018 the outlook remains uncertain. Germany is struggling to put together a workable coalition; Italy goes to the polls with anti-European sentiment high; further afield, the situation in Iran looks ominous; Korea remains a significant geo-political risk. But investors were right to bet that common sense would prevail in 2017. Most likely, it will in 2018 too.

Two other related spectres failed to materialise in 2017. Inflation remained subdued and that, in turn, meant that monetary normalisation traced a flatter path than many feared. Even in the US, where the expected three interest rate hikes were delivered by the Fed, markets took the tightening in their stride.

It is a tribute to Janet Yellen's understated management of market expectations that there were no market corrections to talk of in 2017. Compared with the taper tantrum that greeted Ben Bernanke's tightening hints in 2013, the response to the Yellen swansong has been muted. There is no reason that this should not continue in 2018 under Jay Powell. More of the same must be investors' central case when it comes to inflation and interest rates.

So, if the dogs that failed to bark in 2017 remain silent this year too, what might come along to upset investors' best-laid plans? What should investors be worried about today?

My first prediction is that the relative uniformity of asset allocators' views this year will come back to bite investors. The belief that the US is over-priced and likely to underperform cheaper rivals in Europe, Japan and the rest of Asia is such conventional wisdom as we move into 2018 that I begin to worry that America might catch us all off our guard again.

The widespread scorn with which the UK market is viewed might also provide contrarian investors with a profitable opportunity this year. Even a break-down in Brexit talks or the growing likelihood of a Labour Government might have a silver lining if the pound tumbles and the many exporters and overseas earners in the FTSE 100 index benefit.

My central assumption is that Europe will be the best-performing region this year but there is so much uncertainty about this that only a well-diversified portfolio makes sense.

My second forecast is that the billions of dollars of investment funds that have flowed into passive investments in recent years will find themselves stranded in 2018 by a sideways-moving market that instead favours active investment.

Sideways markets are surprisingly common but not generally expected. When there are offsetting positive and negative factors at play, tracking the index is simply dead money. At times like these, out-and-out stock-picking is the best approach.

My final concern is that 2018 turns out to be the year in which investors realise that the rules of the game have changed. In the past, it has paid to simply wait for the right point in the cycle to pick up underperforming companies on the cheap - classic contrarian investing.

Technological disruption - notably by Amazon in the retail space - is undermining this counter-intuitive investment approach. Successful investors this year and for the foreseeable future are instead going to have to ask some serious questions of the companies they invest in - like do they have a future at all? There are many more value traps around today - companies that look cheap but will probably get cheaper still.

As Sherlock Holmes himself might conclude: investing in 2018 looks like being a two-pipe problem.


Tom Stevenson is Investment Director for the Personal Investing business at Fidelity International. Tom joined Fidelity in March 2008. He acts as a spokesman and commentator on investments and is responsible for defining and articulating the Personal Investing business' views. Prior to joining Fidelity, Tom was a financial journalist writing for various publications including Investors Chronicle, The Independent and The Telegraph.


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