Several consistent trends emerged, with riskier asset classes leading returns and generally favourable global economic conditions. Solid growth out of the Eurozone resulted in a robust EUR (rallying 10.42% vs USD and 5.14% vs GBP), which meant as global asset classes rallied, EUR investors received slightly lower returns.
Prudent investors might expect more muted returns in 2018.
The first quarter (Q1) started with a new administration in the United States. Despite the strong debate this caused, the incoming President’s generally pro-business manifesto buoyed markets and confidence. Underpinned by strong growth and low unemployment from previous years, the US saw initial jobless claims reach its lowest level since March 1975 over the quarter. Furthermore, consumer confidence rallied to its highest level since 20071. The positive economic trends gave the Federal Reserve (Fed) enough confidence to hike rates by 0.25%. Across the pond, the UK initiated the much awaited Brexit proceedings. The first quarter established the strong risk favouring trend seen in global equity markets, with Developed Asia and Global Emerging Markets generally leading returns. European Equities also offered investors solid returns as European corporates in the Stoxx Europe 600 Index saw an 11% year-over-year increase in earnings. For our portfolios Asia ex-Japan (Vanguard FTSE Developed Asia ex-Japan ETF: 12.96%), Emerging markets (Vanguard FTSE Emerging Markets ETF: 10.14% ) and Europe (Vanguard Europe ex UK ETF: 7.02%) led returns as UK (iShares FTSE All Stocks Gilt: 1.60%), EU (Vanguard EUR Eurozone government Bond ETF: -1.59%) and US (Vanguard US Treasury Bond ETF: 0.70%) government bonds lagged over the quarter.
The second quarter (Q2) saw global volatility decline as economic growth continued. European unemployment fell to 9.3% (an 8 year low) while China’s economy expanded at a higher than expected 6.9% in Q1 from a year earlier. June saw the Fed hike rates by another 25 basis points along with surprising markets by setting a rough start date of unwinding its balance sheet. The UK economy slowed over the quarter (0.3%) marking the slowest growth since the beginning of 2016. Q2 saw more muted asset class returns, compared to the first, yet riskier asset classes remained in demand. In the portfolios, Japan (iShares MSCI Japan: 5.08%) led returns for the quarter following strong economic data, while Asia ex-Japan (4.05%) and Emerging markets (3.99%) continued to offer robust returns. Historical safe haven asset classes once again bore the brunt of selling as UK Government bonds (Vanguard UK Gilts ETF: -1.97%). EUR Government bonds reversed Q1’s negative trend offering 0.53% (Vanguard EUR Eurozone Government Bond ETF).
July to September proved to be a volatile time given global politics along with natural disasters. Yet, despite hurricanes in the US and sabre-rattling in North Korea, markets remained generally upbeat. The quarter saw fairly consistent return across most equity regions, with the US (Vanguard S&P 500 ETF: 4.38%) and Emerging markets (Vanguard Emerging markets ETF: 7.73%). A consistent trend this year has been the strong EUR which proved a strong headwind in Q3. For comparative purposes the US stock market (Vanguard S&P 500 ETF) was up 4.38% in Q3 in US dollar terms however lost 1.58% in EUR terms.
The last two full months of the years have seen the strong economic data continue. In the US the ISM manufacturing Index hit a 15 year peak in September of 60.89 and only slightly softened in October (58.7). October also saw the European Central Bank (ECB) announcing its plan to wind down its economic stimulus, by cutting its bond buying in half to EUR 30 billion.
It has been a year of risk-taking and portfolios more skewed towards equities benefitted from returns above long-term averages. The EURs strength over the year slightly dampened returns for our clients, and we often field the question if we should not hold more EUR assets in the portfolios for these clients. We believe that when it comes to fixed income it is very important that the fixed income security matches the base currency of the portfolio as foreign exchange (FX) can play havoc on fixed annuity income streams. However, with equities we believe that they underlying assets really are global in nature. Owning a European equity ETF does mean holding shares in European companies, yet those companies generate revenue streams in a variety of currencies all over the world. Which they often hedge internally when reporting. Furthermore, equity markets on average tend to have a natural hedge in place as a falling (or rising) currency is usually met with a rising (or falling) local stock market.
Our most selected asset allocations by our clients, by far, is 20% Fixed Income and 80% Equities. Using the historical returns of the ETFs that make up our portfolios today a hypothetical portfolio (with a 0.48% management fee) would have returned 7.99% in GBP terms, 7,63% in EUR terms and 11.98% in USD terms. Although European investors lost for most of the year, the weaker EUR/USD over October and November has meant returns year-to-date as at the end of November are relatively on par with GBP base currency investors.The returns in a 20/80 model portfolio this year have therefore been above average and in fact match long term equity returns. We can only hope for similar market conditions next year. However, by March 2018 we could reach an historic 9 years of this bull market. Prudent investors therefore might expect more muted returns in 2018.