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Equity investors have enjoyed an easy ride for much of the past decade as a result of the extraordinary polices implemented by major central banks. Initially, these measures helped stabilise economies in the wake of the global financial crisis, and have now paved the way for robust and broad-based growth.
Indeed, policymakers now believe that the global economy is strong enough to be weaned off life support. They are looking to hike rather than cut interest rates and will gradually turn off the taps that have seen trillions of dollars flow into financial markets and prompted a surge in the value of bonds and equities.
So given that many equity markets reached record highs in 2017, where are they likely to head next?
Rising interest rates are likely to provide a headwind for share prices, but it should be remembered that central banks’ assistance is being withdrawn for a reason, namely stronger economic growth.
Rising interest rates are likely to provide a headwind for share prices, but it should be remembered that central banks’ assistance is being withdrawn for a reason, namely stronger economic growth. That should feed through into higher profits, which ought to support share prices. That’s because reported profits, and expectations of future profits, exert a major influence on the direction of a company’s share price.
The prospects for European equities seem particularly positive given the rapidly-improving economic background. There also seems less chance that political shocks will rock the euro-zone, while European shares appear attractively priced compared to other global markets.
Elsewhere, the positive global economic outlook should benefit emerging market economies, many of which are driven by exports. Although share prices in these markets have already increased sharply in value, they remain significantly lower than in developed markets. That discount looks excessive, especially given the pace at which profits growth in emerging economies has outstripped that seen in developed markets.
However, on a word of caution, it is important to note that the rally in emerging market equities has been driven largely by China, specifically some of its largest technology companies. So an economic or political shock in that country, not that we are expecting either, could threaten emerging market stocks in general.
The picture is more mixed for the US. Although profits have been growing strongly, share valuations look high relative to other regions. Nevertheless, the prospect of tax cuts should help support US stocks, since companies will be able to retain more of their profits which they can feed back to shareholders.
Financial stocks could also benefit from the appointment of the new head of the Federal Reserve, the US central bank, given that he is believed to favour lighter-touch regulation of the sector, which should be positive for profits growth.
On the other hand, US sectors such as telecoms and retail remain challenged. And if interest rates were to rise faster than expected, highly-indebted companies, especially smaller businesses, could be vulnerable.
The outlook for UK equities is clouded by the uncertain political and economic outlook, although there are some opportunities among individual stocks. The big oil companies, for example, look attractive given the strong rally in the price of oil since last summer. The UK also has a few world-leading technology companies of varying sizes and some continue to look appealing long-term investments.
So overall, equities should be able to make further advances this year given the improving global economic outlook and the positive outlook for profits growth. But, as ever, there are risks and some markets certainly appear to offer greater potential than others. Carefully assessing which stocks and markets to plump for, perhaps by investing via a professionally-managed fund, may be a prudent strategy for investors.