Save, make, understand money

Experienced Investor

Equities: where should you invest in 2018?

Paloma Kubiak
Written By:
Paloma Kubiak

The last year has been a strong one for equity markets with many delivering double-digit returns. As we head into 2018, Fidelity’s fund managers share their investment outlooks.

Investors have been rewarded for backing risk assets in 2017, but given we’re in the second-longest bull market on record, investors are questioning whether it’s sustainable.

Equity markets have returned the following (up to 30 November 2017):

  • Asia Pacific Equities: 21.55%
  • Emerging Market Equities: 21.3%
  • European Equities ex UK: 16.38%
  • Japanese Equities: 12.7%
  • Global Equities: 11.9%
  • US Equities: 9.99%
  • UK Equities: 7.9%.

Below, Fidelity’s regional equity portfolio managers outline their investment outlooks for 2018:

Asian Equities

Dhananjay Phadnis, Fidelity Emerging Asia Fund

2017 has been a strong year for Asian equities in absolute terms as well as relative to other emerging and developed markets. Going into 2018, I think we could be entering a period of consolidation as all the above drivers seem to be weakening at the margin.

The US dollar may find support from a healthy US economy with low unemployment and robust wage growth, and outpace emerging market currencies. China’s liquidity binge is already showing signs of reversal with a sharp fall in new project announcements and a clampdown on shadow banking. Finally, earnings revisions in Asia, which have been driven by a narrow set of stocks in the semi-conductor and financials space, seem to be peaking.

Meanwhile, market valuation in Asia, as measured by price-to-earnings ratio, is now about one standard deviation above its long-term average. This will look reasonable only if earnings continue to grow at a decent pace. The good news is that Asian stock valuations continue to remain attractive relative to the developed world.

Emerging Market Equities

Nick Price, Fidelity Emerging Markets Fund

The impressive run in 2017 was set against a backdrop of better economic data, less pronounced dollar strength, stronger local currencies and more robust commodity prices. These factors, coupled with EM earnings growth and an improvement in profitability, have helped to restore confidence.

Despite a period of superior performance, it is critical to highlight that EM is rising from a very low base, and with a heavy valuation discount to developed market equities, the asset class remains attractive.

Policy developments across the major economies of the developing world bode well. In India, Modi’s reform agenda continues to progress. In China, aspects of government policy are encouraging, with environmental and state-owned enterprise (SOE) reform among the areas to watch.

The implementation of bold changes should drive greater economic stability over the medium to long-term. More broadly, measures to address housing issues in India (under the banner of ‘housing for all’) and far reaching healthcare reforms in China can provide us as stocks pickers with multi-year growth opportunities.

European Equities

Matthew Siddle, Fidelity European Growth Fund

Macroeconomic data are positive in Europe with GDP growth robust across the core and periphery. Consumer and business confidence are strong, and lead indicators are at elevated levels. This has fed through to the corporate level and we have seen returns and earnings for European companies begin to catch up with their US counterparts. It is worth remembering however, that we are no longer early in the cycle, with European margins (excluding commodity companies) back to peak levels.

This economic acceleration has fed a willingness to take risk, with investors increasingly paying up for risk whether it be in equities or credit, where plenty of European high yield corporates can now borrow cheaper than the US government. This means that while I am positive on the economic environment for Europe in 2018, I am more cautious on the prospects for a series of riskier companies to outperform.

Lead indicators are at highs not seen since 2007. Expectations are very high, and even a mid-cycle slowdown in lead indicators tends to drive rotation toward less risky companies. While it has not yet occurred, the timing of any market inflection is a very important question for 2018.

Japanese Equities

Nicholas Price, Fidelity Japanese Values plc

In terms of corporate fundamentals and valuations, Japanese stocks are relatively cheap globally and the earnings environment is positive, which suggests a reasonable level of upside for the market in 2018. However, there are signs that momentum in the US ISM index may be peaking. Bottom up and individual company fundamentals will be increasingly important as the pace of global growth starts to slow, and I am focusing on companies that can maintain a steady rate of growth and trade on reasonable valuations.

Key events include the likely reappointment of Haruhiko Kuroda as Governor of the Bank of Japan (BoJ) once his term ends in April 2018, and whether the BoJ starts to taper more. The Japanese labour market is relatively tight and I am looking at companies that can benefit from that trend, as well as growth markets such as medical technology.

Global Equities

Jeremy Podger, Fidelity Global Special Situations Fund

There is a lot of scope for surprise in 2018. We could see more geopolitical uncertainty with a larger effect on markets than this year, but the nature and intricacies of such uncertainty are very difficult to predict.

The market could also be surprised by rising inflation. At the moment, inflationary pressures do appear under control but that could change if economies start to run too hot.

Regionally, Japanese equities are still well below the levels of the late 1990s, but in 2017 they reached a 25-year high. Earnings growth in Japan is expected to reach 20% in 2017, but consensus forecasts that rate to slow sharply in 2018, although it is still expected to remain in positive territory. I think there is potential for Japanese profits to surprise investors on the upside in 2018, resulting in another leg up in that market.

US Equities

Angel Agudo, Fidelity American Special Situations Fund

The US economy has entered the later stages of the business cycle, with the unemployment rate close to previous lows, and monetary stimulus being reduced.  The US stock market has been in a bull run for nearly a decade and valuations are far from being cheap. Aggregate profit margins across sectors are near all-time highs.

Consequently, there is now a large set of companies that either look stretched from a valuations perspective, or have reasonable valuations and safe business models but worse balance sheets.

At the same time, there are also sectors where companies have been more prudent, given their past mistakes; for example, banks have never been better capitalised and energy companies have discovered a new level of financial discipline.

In such an environment, it is important to be fundamentally driven, and to look for bottom-up stock picks within sectors. It is also crucial to look for opportunities which provide good downside protection. Generally, I am looking for investments which have some counter-cyclical characteristics, generate stable cash flows, and have pristine balance sheets.

UK Equities

Alex Wright, Fidelity Special Situations Fund and Fidelity Special Values PLC

Clearly, the spectre of Brexit looms large and greater certainty over the direction of negotiations between the UK and European Union would be welcomed. Such clarity would provide a real world boost to the domestic economy as it would enable firms to have more confidence when it comes to making operational decisions around investment and hiring.

“Outside of the political sphere, another key thing for UK investors to monitor will be the Bank of England. Further policy ‘normalisation’ could have profound implications for the leadership of equity markets from here. We’ve had 10 years since the financial crisis where steady businesses with stable cash flows have been in favour and this has driven strong growth in the share prices of areas like consumer staples. These types of companies have historically struggled in an environment of rising interest rates and we could now be at a point of change where the market may start to reassess the prospects of hitherto unloved sectors.

In particular, banks could continue to positively surprise investors in the coming months. Valuations are attractive as they have been out of favour for some time, with most investors viewing banks as one of the riskiest sectors in the market. This viewpoint is understandable, albeit one that I fundamentally disagree with. The trauma and aftermath of the crisis still dominates the collective imagination of the market, and seems to be preventing investors from recognising the profound changes that have occurred inside banks and in the external operating environment.

Intense regulatory scrutiny means balance sheets are now generally much stronger than they have been for some time and the loans that are being written would seem to be much less risky than those made pre-2007. Regulators are also now becoming more willing for banks to make sizeable distributions to shareholders in the form of dividends and share buybacks.