Royal Bank of Scotland Group (The) (RBS)
Tips for income seekers in 2017
Are equities in a healthy state right now?
Yes I do think equities are in a healthy place right now, so long as we don't get inflation coming through in the US too fast, too soon. This will lead the Fed to raise interest rates higher than is being anticipated.
As long as the Fed in this cycle can keep rates safe at around 2.5-3% maximum - which is what the Fed considers the new natural rate of interest - then it will still be attractive to buy many US and global stocks on account of the relatively generous dividend yields available.
These dividend yields are also likely to grow as the economy grows, unlike fixed income returns where the coupon remains the same for however long you hold it. I think on that important method of valuation, equities are in a reasonably safe place.
I am aware of the argument that Shiller PE ratios (cyclically adjusted price/earnings ratios) are near cyclical highs, but I discount it on the basis that so much of the information going into that number is based on previous times when interest rates were much higher. You can't really compare the current cycle with previous ones.
We talked a year ago about a correction in 2016. Are we in for another in 2017?
There is a risk of a correction is global stockmarkets in 2017. One source is geopolitical risk; perhaps this will be located in the Trump's presidency if ructions with overseas countries boil over much faster than we have seen in previous crises. We've already seen a flight to gold, the dollar and to defensive assets as nobody wants to hold risk assets.
The other source of risk is if the Fed raises interest rates too fast, too soon, perhaps because it fears a rise of inflation as Trump applies a huge stimulus package to the economy.
This could bring down not only the American economy and all the prospects of future corporate earnings growth that currently look quite good, but a decline in the American economy could spread across to global demand.
High-yielding equities are not cheap. Any advice for those seeking income over the next year?
High-yielding equities do not offer the value they did a few years ago because income seeking investors have been chasing them, sending the PE ratio up and the yield down. However, high-yielding equities are still the only place that an income-seeking investor can go to get a reliable income, so I think they are secure for the time being.
They will come under pressure as the Fed and other Central Banks start to raise interest rates as global growth returns, led by the US economy, but we are certainly not there yet.
If an investor is seeking an alternative for income I would recommend property and corporate bonds - not necessarily a corporate bond fund, but individual bonds buying to maturity.
I'm particularly interested in some of the quality bank debt in the UK - for instance, the Bank of England has just done a stress test on the major banks and apart from RBS (RBS), which quite predictably failed, generally the banks came out OK.
There was a demand that some of them raise more capital, but I think that their debt is relatively secure and you can get some good dividend yields on it.
I would avoid perpetual bonds to look for debt with a maturity date so I know I am getting my money on a certain date. I wouldn't put too much money in that particular sector but I do think it's interesting for income-seeking investors.
Which sector are you backing for 2017?
My preferred sector for next year is US financials. Why? Because Donald Trump wants to deregulate US financials and get rid of all the legislation that was passed after the financial crisis. This will enable them to put more capital to use to grow profits and perhaps get back into the highly profitable business of proprietary trading, which incidentally had the added effect of providing more liquidity to global bond and equity markets.
There is another reason why I quite like financials, and that is because as US interest rates go up and US bond yields rise, particularly at the longer end of the curve, the spreads available for banks increase. Their profit margins increase as they borrow short-term debt at low rates but lend out 25-year mortgages at much higher rates because the yield curve has risen.
That difference in the rate they borrow money for and what they lend out at falls straight to the bottom line, increasing their profitability.
I would add that there is a strand of "Trumpism" that is very much in favour of bashing Wall Street, I suspect there will be an accommodation made with Wall Street as so many members of congress receive substantial funding for their campaigns from that said street.
What is the likely outcome of Brexit for investors
The outcome for investors from Brexit negotiations will depend on whether we get a hard Brexit or a soft Brexit. A hard Brexit is where we totally leave with no transitional arrangement and then renegotiate trading agreements with the EU.
This appears to be the opening gambit of the European Commission in Brussels. In this instance we will see sterling fall further and domestic UK stocks under-perform due to the risk of much slower economic growth.
FTSE 100 (UKX) multi-nationals will do much as they have done during previous Brexit shocks this year: the fall in sterling will actually mean their UK share price will hold, or even go up.
If there is a soft Brexit, where we formally leave the EU, but continue to pay into the budget and be part of the single market - a relationship perhaps like Norway or Switzerland - markets will be relieved and we will see sterling rally, which will actually hurt the FTSE 100 companies in the translation of dollar earnings into sterling.
Smaller mid-cap stocks will also go up as it means any disruption to the UK economy will be much less.
This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.