While investors will need to remain vigilant for geopolitical threats in 2018, market conditions could pave the way for further equity returns, according to Jupiter Asset Management’s Edward Bonham-Carter.
Developed markets have continued to plough ahead in 2017 with investors increasingly questioning how long the current bull-run has left.
As the below chart shows, in sterling terms, the MSCI World index has delivered a total return of 12.38 per cent and the S&P 500 index has produced an 11.87 per cent gain.
The blue-chip FTSE 100 index has generated a total return of 9.12 per cent this year despite several sources of uncertainty clouding the UK economy.
Performance of indices YTD
Source: FE Analytics
With markets continuing to rise, investors and fund managers have found it increasingly difficult to forecast their future direction.
Jupiter’s Bonham-Carter said markets have proved difficult for to navigate and believes the current environment could continue into the new year.
He said: “Over the last 12 months, economies and investment markets have been behaving in ways that have been confounding investors and economists alike.
“There is little reason to think that won’t continue to be the case in 2018.”
The investment veteran said one of the key challenges this year has been the rise in global stocks against a backdrop of increasingly negative headlines that would have inhibited investor risk appetite in previous years.
He highlighted ongoing Brexit negotiations, the rise of populist politics in Europe, Donald Trump’s presidential style, and unrest in the Middle East as having the ability to affect markets negatively.
“While markets have remained calm, situations that appear contained can quickly flare up, prompting markets to fall,” Bonham-Carter explained.
“It will therefore be more important than ever to remain vigilant to these geopolitical threats in the year ahead.”
Indeed, Bonham-Carter’s concerns about markets have been highlighted by the low levels of volatility as represented by the VIX – the so-called ‘fear index’ – which has continued to trade at low levels this year.
The low levels of the VIX have added to increased levels of anxiety among investors concerned about an impending market correction.
With markets continuing to rise, investors have become more focused on valuations and some have warned of bubbles as passive inflows have poured into the market inflating prices.
Bonham-Carter (pictured) said the trend was “perplexing” noting that major indices such as the FTSE All Share, S&P 500 and MSCI Emerging Markets index were all trading close to historic highs.
“It is this combination of troubling news headlines and high valuations that makes this stock market rally, in my view, a mirthless one, and potentially one that is ripe for a reversal,” he said.
“There is a sense that the party cannot go on for much longer, and there is much talk in the market that the coming year will be a more challenging one.
He added: “We’ve heard such predictions before, especially from those who are underinvested in the market and are looking for prices to fall so they can jump in, but this time, arguably, there is greater reason to think it might actually occur.”
Despite concerns over the markets, Bonham-Carter said economic growth is likely to remain supportive heading into 2018.
He said developed markets were enjoying a “Goldilocks moment” where growth is not strong enough to fuel inflation nor too weak to cause higher unemployment.
However, he said inflation is likely to remain a cause for concern next year.
UK inflation 2011-2017
Source: OECD
“There is a question mark over how long wage growth can remain subdued in countries like the UK and the US, with labour markets being so tight,” he explained.
“The labour force’s bargaining power on wages is much less strong than in the past, as people are effectively importing cheap labour as they buy increasing amounts of products online that have been manufactured abroad in low-wage countries.”
Additionally, technological innovation has continued to make inroads into all areas of the global economy, he said, “capping or driving down the prices of goods and services”.
Bonham-Carter (pictured) added: “Should inflation pick up, we can expect the US Federal Reserve and other central banks to quicken the pace of interest rate rises.” 
A rising rate environment would continue to favour shares over bonds, but market confidence might be shaken should higher rates put more companies and individuals into bankruptcy and slow economic growth, he said.
Supportive central bank policy in the form of quantitative easing and interest rate cuts have distorted assets for a long time, Bonham-Carter explained, in a bid to boost growth.
“Any attempt to bring interest rates back to their historical averages may prove painful, especially if it is done too quickly,” he said.
“Given how long rates have been kept low, when we talk about a reversion to the mean, the question remains what ‘mean’ do we mean? Do we take a 10-year or 20-year historical average, or do we go even further back? That is one more conundrum for 2018.”
However, he said that it was unlikely that central bankers would extinguish the growth they have worked so hard for by raising rates too quickly.
He added: “Shares, in that context, should be able to post reasonable returns so long as inflation doesn’t spike and we see a slow but steady rise in interest rates.
“For bonds, the key, in an inflationary environment, is flexibility. A strategy that is able to invest in all areas of the bond market has a better chance, in my view, of weathering what may prove to be a tricky year for bonds.
“Long-term investment trends, meanwhile, favour emerging markets, but, as ever, resolve will be needed to ride out the inherent volatility of the maturing economies that underpin the