2017 might have been a politically turbulent year, with geo-political tensions such as Brexit and North Korea dominating the headlines.

But for markets, 2017 was actually an outstanding 12 months, characterised by strong performance and low volatility.

The FTSE 100 reached all-time highs on numerous occasions and finished the year with yet another record close.

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New all-time levels were also reached on markets in the US, South Korea, India and Germany.

There is a synchronised economic recovery taking place that is likely to continue in many of the world’s major regions and this should provide a platform for respectable returns.

Indeed, in 2018 we could well see more stock market records; the consensus is that global growth will hit 3.5 per cent to four per cent this year, with most G7 economies predicted to expand by more than two per cent.

The US market should be boosted by President Trump’s business-friendly tax package and should mean continuing strong profits growth, which is supportive for equities.

A note of caution, however, would be that 2017 was almost as good as it gets on the markets, so there is now more room for disappointment than in previous years.

Why 2018 could be more volatile

RISING interest rates and high equity valuations provide cause for caution, but interest rates would have to rise significantly before investors felt their assets would be better off in cash or bonds than equities.

Interestingly, however, research by Brewin Dolphin shows the correlation between interest rates and equity performance may have been overplayed.

Our data suggests that, in fact, the extraordinary growth in global M1 money supply in the latest cycle shows a stronger correlation with market outperformance than the level of interest rates.

Crucially, one of the main drivers of this is China.

The China effect

M1 money supply essentially refers to liquid cash and this is generally created by the combined actions of policymakers and banks.

Although the developed world’s central banks have been infamous for the stimulus they have imparted, more recently China has been the most aggressive chaser of growth.

During the financial crisis, Chinese banks embarked on a lending spree to sustain its economic growth.

But our research shows that, in 2016, China’s policy was even looser, resulting in a glut of M1 money entering the global economy.

As a combined result, total debt to companies and individuals in China has risen from $6 trillion during the financial crisis to around $28 trillion at the end of last year.

That took its debt from 140 per cent of GDP to 260 per cent of GDP over the same period and makes China’s companies the most highly leveraged in the world.

China is now a bigger contributor to global GDP and money supply growth than it has ever been, meaning it has a proportionately greater influence on global markets.

China slowdown and other things to watch…

PRESIDENT Xi Jinping wants to address China’s huge debt, so we expect China to continue raising interest rates and introducing capital controls.

Not only might this slow the Chinese economy, it should reduce its contribution to M1 money supply this year, which in turn would mean less money available for investment in global equities.

That is a recipe for volatility and potential market corrections.

Also in the mix are concerns about Brexit, which could easily unsettle markets, and possibly a slowdown in the US, although strong corporate profits and Trump’s pro-business agenda could extend the US bull run still further.

With all this in mind, investors should be optimistic for 2018, but prepared for a few more bumps in the road along the way.

As Brexit matures, US rates continue to rise and the world sees a possible tightening of liquidity through the money supply, it may be that the investing “highway” feels a little less like the smooth tarmac of 2017 and more like driving off-road as this cycle hits its peak.

More volatility means more opportunity for active investors with strong nerves.

Matthew Worton is a trainee investment manager at wealth management firm Brewin Dolphin, in Newcastle

The opinions expressed in this article are not necessarily the views held throughout Brewin Dolphin. No director, representative or employee of Brewin Dolphin accepts liability for any direct or consequential loss arising from the use of this document or its contents. Any tax allowances or thresholds mentioned are based on personal circumstances and current legislation which is subject to change. The value of investments can fall and you may get back less than you invested. The information is for illustrative purposes only and is not intended as investment advice.