Outlook 2018: US equities

Source: Schroders/Credit Suisse December 2017. Past Performance is not a guide to future performance and may not be repeated

Wage growth is broadening out

Finally, although we are approaching a decade of economic growth, up to this point, much of the wage growth generated has not filtered down into lower income households. This is showing signs of change; wage growth in higher income brackets has not weakened but wage growth for lower income brackets is accelerating sharply. The implication of this trend should be that consumer-facing companies outside the luxury space should disproportionately prosper.

Of course, correctly identifying the potential winners and losers from the trend is more complicated. Amongst other things, investors should consider the nature of a company's labour pool. Widespread wage growth for lower income consumers may indeed drive higher sales for a company like Walmart or Starbucks. But earnings may improve little - or not at all - if the wage bill (for largely minimum-wage staff) is also set to rise. If on the other hand, the company has been engaging with disruptive technology - perhaps automating aspects of its order fulfilment - it may indeed see improved profitability.

Disrupting the cycle

The above example touches on the importance of recognising and engaging with disruption in an environment of elevated valuations. Although markets look well supported, current market levels do not leave a great deal of margin for error. Furthermore, even if valuations overall remain high, this can mask significant changes within the market's composite sectors and companies that can still hurt returns.

We anticipate, for example, a major transformation in the energy and automotive industries over the next two decades. A very powerful combination of competitive renewable energy, improving battery storage costs and desirable electrically powered vehicles is emerging to forge a viable path towards de-carbonisation of energy and transportation. We do not, of course, expect the transition to be linear. Navigating the transition may be as much about avoiding the losers, as finding the winners.

We are also now familiar with Amazon's retail model: a large warehouse is used to house stock that is distributed by to us directly by courier. The old retail model - seeking market share by rolling stores out nationwide - is far more vulnerable to changes in the economic backdrop. If fears over 'stranded assets' in major energy firms are rising, are the risks any lower for redundant retail space?

These are only two examples that will change the face of markets in years to come. In our view, innovation is always at the heart of sustained growth. For companies to enhance the durability of their earnings over the long term, we believe they need to deliver innovation. Companies that innovate successfully are likely to be significantly rewarded by investors: those that don't will almost certainly be over-whelmed by the pace of change.

Our approach

On balance therefore, the fact that US equities are at relative highs is not an immediate cause for concern for us as we approach 2018. That is not to say there are no risks. Political uncertainty has risen in again in Europe, with Germany struggling to form a new coalition. We also have a US President perhaps better known for unpredictability than political consistency. Furthermore, equity market support is contingent on inflation remaining benign; far from assured. A sharp rise in inflation could induce a change to current monetary policy support. For us, this is all the more reason to take a longer-term view, seeking companies that are less dependent on the economic cycle.

Well-managed companies, with cultures that support ongoing innovation, performance and accountability, will be better placed to deliver superior returns irrespective of the economic cycle. Our focus will continue to be on searching for these individual situations that fit our investment philosophy on a global basis, rather than attempting to time allocations to regions or sectors. In a globalized world, there are always opportunities at the company level.

The full range of our Outlooks 2018 series of articles is availablehere