Where to invest in 2018?

Burning Question proper size
Burning Question proper size

This year has been a positive one for the FTSE 100. It has risen by almost 6%, and when its 3.5% dividend is added to the figure, it has delivered a total return of just below 10%. If it performed this strongly every year, then investors would generally be happy.

However, drilling down into that performance highlights a two-tier market. While cyclical stocks have become more popular and have benefitted from continued momentum in the global economy, defensive income stocks have been relatively unloved. This could provide an opportunity for long-term investors to capitalise in 2018.

How I fared in 2017

As someone with a diversified portfolio of shares, my own performance has been positive in 2017. Small-caps have continued to perform well, with riskier mid and large-caps that are growth-focused having generated surprisingly strong earnings growth. Major holdings such as Unilever (+24%) and Diageo (+27%) have made strong progress, while resources shares such as KAZ Minerals (+128%) and housebuilders such as Berkeley Group (+48%) have also been impressive performers.

However, there have been disappointments, too. As mentioned, defensive income stocks have generally underperformed this year as investors have adopted a more 'risk-on' strategy. Therefore, tobacco stocks such as Imperial Brands (-11%) and healthcare companies such as GlaxoSmithKline (-16%) have underperformed the index by a significant amount. Overall, though, 2017 has been a positive year for most investors with diversified portfolios.

Looking ahead

The decline in valuations of various defensive stocks means that there could be numerous buying opportunities for next year. Imperial Brands and GlaxoSmithKline, for example, trade on price-to-earnings (P/E) ratios of just 11 and 12 respectively. They are low by historic standards as well as when compared to some of the global peers.

Certainly, the bull market of 2017 may last into 2018. However, with risks such as North Korea, US political uncertainty and Brexit likely to still be on the radar over the next 12 months, defensive shares could perform much better next year.

Investors may also decide that the valuations of cyclical companies are overly generous and may begin to seek better value opportunities. Since a number of defensive shares now trade on low valuations, they could be among the most popular stocks in the next year. Similarly, gold-mining companies could post impressive gains next year based on the defensive characteristics of the precious metal.

Income potential

With inflation now reaching 3.1%, income stocks could also be viewed as more attractive by investors. With Imperial Brands and GlaxoSmithKline yielding 6%+ each, and many of their FTSE 100 peers offering 5%+ yields, beating inflation at 3.1% is not particularly challenging. However, if inflation continues to rise in the coming months, then it could lead to yield compression among many of the FTSE 100's largest companies by market capitalisation.

Of course, predicting the future is always fraught with difficulty. But history shows that no bull market ever lasts, and with a number of defensive income stocks offering low valuations and high yields, they could be the best stocks to buy next year!

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Peter Stephens owns shares in Unilever, Diageo, GlaxoSmithKline, Imperial Brands, KAZ Minerals and Berkeley Group. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline and Unilever. The Motley Fool UK has recommended Diageo and Imperial Brands. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.