LOOKING ahead to 2018, we consider how best to capture the opportunities that markets offer, while being mindful of the risks that will occasionally grab the headlines. As investors, we first need to ask what it is we are looking for: income, growth, or a balance of both.

From an income perspective, the Bank of England has tentatively begun to raise interest rates, while other central banks, such as the US Federal Reserve, are being more aggressive. However, this still looks to be a world of low interest rates by any historical standard. Therefore, long-dated government bonds offer little value, meaning corporate bonds, high-yield rather than investment grade, and emerging market bonds should be considered. Equally, infrastructure, real estate and equity income investments could be looked at.

However, there are risks around such investments, not least of which is inflation. If this picks up sharply and central banks respond with higher interest rates, the price of bonds will decline. Another risk is a sharp hit to the ability of some governments or companies to repay debt, which would put bonds under pressure. This could come from a downturn in profits or a commodity price shock that hurts certain emerging markets.

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For growth assets, 2017 was a good year. With a few weeks to go, UK equities have returned seven per cent and global equities in sterling terms have returned 12 per cent, with both figures including capital gains and dividends. Can this continue in 2018/19 given many commentators are warning about expensive valuations, while others are worried about an ever-growing array of political risks?

My response to these concerns is that valuations are important but not sufficient while P for profits trumps P for politics. Yes, certain markets and sectors look expensive. This is partly because much lower interest rates and quantitative easing policies have inflated all asset prices, and partly investor confidence has increased as fears about the financial or eurozone crises have receded.

However, we should not forget that a profits recession – caused by pressures on manufacturing and oil and gas – came to an end in 2016. 2017 has seen profits growing by 10 to 15 per cent a year and the signs are for five to 10 per cent growth in 2018. Furthermore, history shows that expensive valuations are not sufficient on their own to trigger a decline in asset prices. Some other shock is needed – whether to growth, to borrowing costs or to investor sentiment.

The positive news is that growth prospects for 2018 look good. Currently, the world economy is ticking along nicely. A virtuous circle of higher business investment, lower unemployment, improving consumer spending and global trade is taking hold. For investors looking for growth, we suggest global equities over real estate or corporate bonds. We also believe there is more value in European and emerging market equities ahead of the US and Japan, in turn ahead of the UK.

Looking ahead to 2018, the key factor to watch is inflation, not growth. In 2017, a variety of factors have restrained inflation, so much so that Janet Yellen, outgoing chair of the US Federal Reserve, admitted that “inflation is a mystery”. While headline inflation in the larger economies should rise moderately in 2018, any significant surprise to the upside or downside would trigger a sharp reaction in markets, given that most investors are assuming that central banks will not be aggressive when tightening monetary policy.

Just because markets coped with political and geopolitical issues in 2017 does not necessarily mean the same for 2018. Possible sources of volatility include: North Korea; elections in Italy; tensions between Saudi Arabia and Iran; a failure to renegotiate the North American Free Trade Agreement; and, of course, the multiple possible outcomes to Brexit negotiations.

As 2017 draws to a close, holding a diversified portfolio of assets, with some cash ready to invest, will ensure investors can capture the opportunities, while providing greater resilience when the inevitable bumps in the road arrive.

Andrew Milligan is head of global strategy at Aberdeen Standard Investments.