I have to say I always dislike writing “the year ahead” pieces at this time of year because in my way of thinking the change of calendar year is broadly meaningless in the overall scheme of investing. I see investing as similar to a game of sport, but one where there is no “full-time siren”.

Investing is about cycles, not dates. The question becomes where are we in the economic and investment cycle? That is far more important than anything when it comes to growing and preserving your investment capital.

We are in a period of synchronised global growth. All major economic jurisdictions of the world are growing. This will continue to drive profit growth in equities and eventually some inflation as slackness in labour markets dissipates.

China is growing strongly, the Eurozone is recovering strongly, the USA is also doing well as is broader Asia. Australia is growing, albeit GDP growth rates will be lower than the rest of the world as the housing construction and house price cycle peaks. Household indebtedness will also drag on Australian GDP.

1. Interest rates have bottomed

This strong synchronised global growth means one thing for sure: interest rates have bottomed for your lifetime.

I am absolutely certain we are past the bottom of the global and domestic interest rate cycle. You will never see interest rates or long bond yields lower than these levels. Central banks, led by the US Federal Reserve, have commenced the interest rate normalisation cycle and have also started to shrink their enormous balance sheets. Ten years after the GFC, we are heading into a more normalised interest rate environment. Hopefully, sensible people and companies have used this period of record low interest to pay down their debt rather than take on record levels of obligations.

In my view, this will be the most prominent feature of 2018. I expect the Fed to raise US cash rates three times. I also expect the ECB to end its QE program and raise cash rates twice. In Australia, I expect the RBA to raise cash rates once later in the year, but Australian variable mortgage rates will be rising as Australian banks pass on the rising cost of their global wholesale funding. Make no mistake, Australian mortgage interest rates will increase in 2018 due to rising global interest rates driving up the cost of funding for Australian banks.

This rising interest rate environment has clear ramifications for asset allocation. I see real capital loss dangers in bond markets and bond like equities. I also feel Australian residential house prices will fall 5% in 2018 as supply arrives and the cost of borrowing increases. In fact, I think all Australian property will fall mildly in 2018 (including listed property trusts), and you will see money at the margin switch from property and fixed income investment to global and domestic equities. This negative property sentiment will also affect the Australian consumer who will reduce discretionary spending a notch and focus on debt servicing as those costs rise.

2. Focus on value and cyclical equities

Value and cyclical equities, both global and domestic is the place to be in a rising interest rate environment. I can see a scenario where value and cyclical equities, beat all other asset classes handsomely in the year ahead on a total returns basis. I am particularly bullish on global financials in this rising interest rate environment. Global banks are going to have macroeconomic tailwinds in terms of rising interest rates and steepening yield curves for the first time in a decade. With the exception of Australia (Royal Commission), they also have falling regulatory risk. In fact, the regulatory burden is easing for banks in Europe and the USA. Global banks and global insurers are both value and cyclical. I think they are the place to be invested in the year ahead and I even see them outperforming the almighty large-cap tech names that dominated this year.

In essence, the “great rotation” I have written about from bonds to cyclical and value equities will accelerate in the year ahead. In fact, I foresee quite a violent rotation as interest rates, both cash and bond yields, rise faster than current consensus thinking.

That doesn’t mean it will be a bad year for equities, far from it, the weight of financials and cyclicals rising will more than offset the likely falls in highly over-owned long duration stocks that have previously led equity markets. The rotation inside equity markets has every chance of being quite violent and the perfect environment for hedge fund managers to outperform.

3. Chinese equities listed in Hong Kong to outperform

Outside of global financials, the best value, cyclical, and growth combination lies in Chinese equities listed in Hong Kong. I expect further gains from “H shares” in Hong Kong as the investing world starts looking for alternatives to broadly fully-priced US equities. I also expect European equities to outperform US equities in the year ahead as the EU accelerates forward.

I would also focus on individual companies with strong balance sheets, good free cash generation, and sustainable dividend payout ratios that don’t impede growth. The relative price paid for dividend yield will fall in a rising interest rate environment as “bond tourists” cash in their chips in bond-like equities and return to the bond market as yields rise. This is something to remember in equity sectors like utilities, infrastructure, REITS, supermarkets, and healthcare.

My final point is I’d expect volatility to rise in the year as interest rates rise. Ultra-low interest rates have driven ultra-low volatility in equities. If I am right and interest rates rise, driving the “great rotation”, then there should be no doubt that overall volatility will increase in the equity asset class.

However, all in all, I am constructive on global equities in the year ahead. I am maximum bearish bonds, but constructive on global equities with a clear focus on China and the Eurozone. I am very focused on value and cyclicals. I think there are ways of generating solid double-digit returns in 2018, albeit I believe those gains will be driven by a new leadership group in equities: financials.

The new year question you most likely need to need to ask yourself is: do I own enough global banks and insurers?? The answer is most likely not.

I hope you all had a successful 2017. For those invested in the AIM Global High Conviction Fund, I thank you for your support which has seen the fund double in size this year and deliver solid returns. We obviously hope to keep delivering for our investors in 2018. For everyone else, I hope there were a few ideas that helped your portfolio.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.