US optimism resulted in a volatile month for US stocks in December, with the S&P 500 and Dow Jones rising as a result of optimism over President-elect Donald Trump's reflationary spending plans. Elsewhere, cyclical stocks continued to push up the UK index.
The S&P 500 ended the month up just 3.1 per cent and the Russell 2000 ended up 3.9 per cent. But the Association of Investment Companies North American Smaller Companies sector was the second best-performing sector over December, returning 9.8 per cent.
American smaller companies are the focus of much optimism on the grounds that any spending boost is likely to help domestically-facing US corporates. But the journey could be rocky.
"Much depends on policy implementation times, the international response and the tightening effect of a rising US dollar (which has already climbed 5 per cent since the US election and nearly 10 per cent since mid-year on a trade-weighted basis)," says Guy Monson, chief investment officer at Sarasin & Partners. "Either a Republican Congress or the bond market will also need to remind the Trump White House that their pre-election fiscal forecasts took the US national debt up to the same percentage levels as Italy within a decade. Combine this with the lack of government experience of almost every cabinet appointment and a rapidly changing policy agenda, and equity markets may have good reason to pause for breath."
Aside from Trump, inflation and the possibility of interest rate rises have been driving markets. Banks are among the best-performing sectors in the past month, following the second US interest rate hike in a decade in December. Higher interest rates are good for banks, which can pass them on to customers. Small-cap US banks rallied in the immediate wake of the rise and banks are up across the world. The MSCI World/Banks index was up 6.4 per cent over December and the FTSE All-Share Bank index returned 4.3 per cent.
Michelle McGrade, chief investment officer at TD Direct Investing, says banks are likely to continue performing and the theme of growth stocks giving way to value is now well under way.
"We have been talking about the switch from growth to value for a while and now you can be even more specific when it comes to value, because both Donald Trump and UK prime minister Theresa May have said they will spend on infrastructure," she says. "That will boost the markets and also cyclical companies are more likely to lead any market rally. The cyclicals likely to do well include banks, oil and commodities, but also things such as trucks, aggregates, chemicals and construction. All of those areas have been laggards, especially in the US, in recent months."
Oil prices. meanwhile, rallied to their strongest point in at least five years at the start of December following an Organization of the Petroleum Exporting Countries (Opec) decision, which extended to several non-Opec producers, too, to cut crude output and reduce a supply glut that kept prices low in 2016.
Although January has seen that recovery falter as new rigs brought online by shale producers have led to fresh oversupply fears, oil funds were some of the best performers over the past month: the top performer over one month to 9 January was Junior Oils Trust (GB00BH57C751), which returned 15 per cent.
According to broker AJ Bell, mining, oil and gas, banks and insurers will be the sectors driving the UK index in 2017. The FTSE 100 index hit a record high in the last month of 2016, with weaker sterling propelling the benchmark upwards, and miners and financial stocks the biggest gainers.
"An aggregate of bottom-up analysts' consensus forecasts shows that [mining, oil and gas and financials] are forecast to provide 48 per cent of total profit and 50 per cent of total dividend payments in 2017," comment analysts at AJ Bell.
These sectors are also expected to provide 76 per cent of the anticipated £48.7bn increase in FTSE 100 pre-tax profits and 52 per cent of the projected increase in dividends for the year.
Winners, losers and how to position now
The best-performing Investment Association sectors over December were European equities funds. The IA Europe excluding UK, Europe including UK and European Smaller Companies sectors came out on top, returning between 4 and 6 per cent for the month.
In Europe, too, banks are out on top as a weaker euro has pushed investors back into the sector, which lagged behind for much of 2016. At the end of December, European banks were on track for their best quarter since 2009. The Euro Stoxx 50 was up 9 per cent over the month and it is up 27.2 per cent over the year to 9 January. Meanwhile, Euro Stoxx Financials index was up almost 10 per cent over one month and 34.12 per cent over the six months to 31 December.
Gold funds, oil funds and Russia funds were among December's top performing funds while MSCI Russia index returned 84.7 per cent in sterling terms in 2016, although less than half that in local currency. JPM Russia (LU0215049551), Neptune Russia and Greater Russia (GB00B04H0T52) and HSBC GIF Russia Equity (LU0622169059) all appear in the top 10 funds over one month to 9 January.
Ms McGrade says she is now positioning in value-orientated funds. "GLG Undervalued Assets (GB00BFH3NC99) should do well in 2017 as should Investec Special Situations (GB00B29KP103)," she explains. "Richard Buxton, manager of Old Mutual UK Alpha Fund (GB00B946BX62), also holds a lot of banks."
She is also positioning in emerging markets via Fidelity Emerging Markets (GB00B9SMK778) and for a more value-orientated approach M&G Global Emerging Markets (GB00B3FFXX47).
