While markets have shown early signs of ‘more of the same’ in 2018 following last year’s continued bull run in equities, Rathbones’ Julian Chillingworth warns that investors should remain wary of a change in conditions as the year progresses. 
The chief investment officer (pictured) said: “Only a brave investment manager would have told clients at the start of 2017 that the year would produce close to the best annual returns for global equites since 2009.
“By year-end, the FTSE World index was up 21 per cent in dollar terms, having delivered 14 months of advances.”
However, with investors mindful of the ‘more of the same’ conditions in markets, Chillingworth said both the S&P 500 and the FTSE 100 have hit new highs in 2018 while volatility remains muted.
“For those interested in stats, another record has been broken: the longest-running period without a 5 per cent fall for the S&P 500,” he added.
“The index on Monday broke through the previous record of 394 working days, set as the dotcom bubble began to inflate in the late 1990s.”
Performance of the S&P 500 over 2yrs
Source: FE Analytics
“Will this continue?” he asked. “The US Federal Reserve is expected to increase the pace of its interest rate hikes this year, especially now that the US tax cut is law.
“And the Fed is no longer the only major central bank that is expected to tighten monetary policy: upbeat European economic data may lead to a faster unwinding of the continent’s ultra-loose interest rates and quantitative easing programme.”
Indeed, changing central bank policy around the world is likely to have a significant impact on markets in 2018, as the move away from loose monetary policy continues.
Chillingworth added: “Even Japan’s much-maligned economy has been looking much healthier lately, potentially paving the way for a reduction in its mind-boggling level of monetary stimulus.
“Tighter policy around the world would mean higher discount rates and therefore less valuable future cash flows.”
However, while central banks have already begun to hike rates and quantitative easing programmes look to be nearing the end of their lifecycles, policymakers may still remain wary of tightening policy too quickly, said Chillingworth.
With the global financial crisis still fresh in the memory of many rate-setters and economic growth still fragile, many central bankers have avoided making too drastic changes.
But Rathbone’s chief investment officer warned that investors might need to prepare for increased volatility in 2018, if central bankers prove too cautious.
Chillingworth continued: “If this wariness continues, it seems likely tighter monetary policy will be accompanied by decent economic growth, which should feed corporate revenue growth.
“As more valuation components move in different directions, greater volatility could be in the pipe for both bond and equity markets.”
Source: FE Analytics
Indeed, volatility was conspicuous by its absence last year despite a number of potentially geopolitical headwinds, including elections in key European states and the worsening of relations between the US and North Korea over the latter’s missile and nuclear weapons programme.
As such, volatility was lower across major indices – in local currency terms – during 2017 compared with 10-year annualised figures despite these challenges, as the above table shows.
He said: “Politics had very little direct influence on markets in 2017, with investors concentrating on rising earnings across major markets and generally – and eventually – ignoring everything from threats of nuclear apocalypse to the rise of far-right nationalism.”
The question for Chillingworth is whether ‘more of the same’ can be applied to market performance this year, however.
As the bull run in markets has continued investors have become increasingly nervous about how much further it has left to go.
But for Chillingworth, the economic backdrop continues to look stable and supportive of markets in 2018, highlighting the bullish growth forecasts by the International Monetary Fund (IMF).
“Last year, two-thirds of the 25 largest economies grew faster than their long-run averages and the IMF believes that should continue into 2018,” he explained.
Global economic activity forecasts
Source: IMF
The chief investment officer said while the more positive economic growth outlook has buoyed some, the biggest driver of markets has been improving company data such as company earnings.
He said: “US markets became excited about tax cuts, which were finally inked just before Christmas, but most of the year’s upward momentum came from company fundamentals.”
Whether the improvement in corporate data seen last year will continue into 2018 remains to be seen. However, fund managers remain confident they will see ‘more of the same’ in this area, with the latest Bank of America Merrill Lynch Fund Manager Survey showing that 15 per cent of managers believe earnings will rise by 10 per cent or more, the highest level since 2011.
Chillingworth added: “As we come off a strong year for share markets, many dream of another soaring uplift in 2018. Our fingers are definitely crossed. However, we feel it’s more prudent to prepare for a rockier investment landscape.
“Barring a sudden global downturn, equities should offer adequate returns – better than bonds, at least. But expectations should be tempered, lest irrational exuberance get the better of us.”