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For me, investment is about a rational, disciplined analysis of the fundamentals of individual businesses and the broader industries and economies in which they operate. That allows me to form judgements about the intrinsic value of those individual businesses and make investment decisions based upon the differences between the market’s perception of value and my own.

In the broader economic context, I don’t feel the need to form specific forecasts for things like inflation, GDP growth and unemployment – but I do try to form a clear understanding of their likely direction of travel. Again, there is an opportunity to take advantage of differences between my own expectations and those that are implied in market valuations. It’s about trying to understand what’s priced in to the market’s expectations and exploiting situations where the consensus has, for a variety of potential reasons (in my view, for example, markets are neither rational or disciplined most of the time), got things wrong.

Going forward, I expect the investment backdrop to look very different to the one that has prevailed for much of the last three years. And it is an environment for which I am very confident that the Woodford funds are positioned appropriately. Indeed, as you will see on these pages, there is a growing body of evidence to support my view of the world, highlighting the risks that exist in many parts of the market, and the long-term opportunity that our strategy is looking to exploit.

Looking ahead, there are number of things to watch out for in the coming months, and here we explain their implications for financial markets and for the funds.

Neil Woodford

Neil Woodford
Head of Investment

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Global liquidity

In this inter-connected, globalised economy, dollar liquidity is the grease in the wheels of the global financial system…

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China growth

There is growing evidence to suggest that Chinese priorities will be very different to the ‘growth at all costs’ mantra of recent years…

Read more

UK economy

I believe that the market consensus has misread the outlook for the UK, where economic fundamentals are improving, not deteriorating…

Read more

Valuation stretch

The bubble-like characteristics in markets will reverse in 2018, as fundamentals reassert themselves…

Read more

We have been through some challenging performance conditions recently, the product of some disappointing stock specific developments (e.g. Capita, Provident Financial, Prothena) and, more importantly, a late-stage bull market environment that has been increasingly momentum-driven.

The valuation extreme in markets has, in our view, reached breaking point and there are sound reasons to expect a very different investment backdrop in the years ahead than the one that has prevailed – with positive implications for the Woodford funds.

Global liquidity

In this inter-connected, globalised economy, dollar liquidity is key. Its importance as the grease in the wheels of the global financial system is easily under-estimated. We believe that liquidity conditions in the global financial system have already started to tighten and that this is likely to gather pace as the year unfolds. The primary reason for this is that central banks, led by the US Federal Reserve (Fed), are now tightening policy.

Nobody fully understands how the Fed’s quantitative tightening plans will play out because it has never happened before. But from our perspective there are valid reasons to expect tighter global liquidity conditions to act as a brake on economic growth and on financial asset prices.

Our non-consensual strategy has actively avoided areas of the market that look most vulnerable to this in the months and years ahead, focusing instead on stocks that have not benefited from abundant liquidity. As always, valuation guides this disciplined investment approach.

China growth

There is growing evidence to suggest that the priorities of the Chinese authorities going forward will be profoundly different to the ‘growth at all costs’ mantra of the last decade. Policymakers no longer seem prepared to ignore the economic risks that have accompanied several years of unbridled credit expansion.

The economic implications of this are not positive for China in the near-term, nor for the rest of the world. We believe we’ll see progressively slower growth from China as the year unfolds, as the country faces up to its massive bad debt problem and exports deflation to the rest of the world via its currency. The most obvious route back into financial markets here is via a lower contribution to global growth from China and indeed Asia more broadly. A further market impact should arrive through commodity prices, which will not greet the absence of demand growth from China favourably.

The funds have actively avoided exposure to parts of the market that are vulnerable to the slowdown that we expect to see in the Chinese economy.

Improving UK economic fundamentals

We believe that the market consensus has misread the outlook for the UK, where economic fundamentals are improving, not deteriorating. Looking forward, we see UK economic health improving, with more people in work, more wage growth, less inflation, more investment spending, better public finances and a continued recovery in manufacturing and exports. We expect a considerably better growth outcome than the recession that some of the more pessimistic commentators are forecasting and what appears to be priced in to valuations.

If the UK economy performs better than people think, then by extension, it is logical to expect that some companies which are exposed to the UK economy, will also perform much better than people think. Herein lies an opportunity which we have positioned the funds to exploit. The valuations of many housebuilders, construction businesses and retailers are simply too cheap and growth expectations far too low.

We believe that the share prices of many domestically-focused businesses will stage an impressive recovery in 2018 and the funds are positioned to benefit from this.

Valuation stretch to normalise

The bubble-like characteristics that have become increasingly evident in financial markets, add considerable risk to the investment backdrop.

We believe the elastic between the valuation of popular and unpopular stocks is starting to reverse – partly as a result of the macroeconomic conditions described above, but also because fundamentals always eventually have a gravitational effect, which pulls share prices into closer alignment with reality.

It is a simple mantra but all we’re trying to do is avoid the risk and capture the opportunity. This leaves us confident of delivering the attractive and positive long-term returns that investors have come to expect from Woodford funds.

Woodford Investment Management Ltd is authorised and regulated by the Financial Conduct Authority (firm reference number 745433). Incorporated in England and Wales, company number 10118169. Registered address: 27 Old Gloucester Street, London, WC1N 3AX.

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