Market Commentary – 3rd January 2018
A buoyant global economy
The most important point heading into 2018 is that we are seeing synchronised global growth throughout the global economy, at its strongest pace of expansion since the 2007/8 financial crisis. Given where we are in the economic cycle there will always be some form of risk of a recession over the next 12 months, however those risks are quite subdued given the current strength of the economic data. If we pay attention to the pace of growth, the economic data is slowing down from a rate of change perspective.
Economic indicators are pointing to an acceleration in the global economy. The OECD’s indicators of industrial and consumer confidence, for instance, are at their highest since 2000. But what of valuations and growth? Companies that have grown revenues at 50% in 2017 are expected to keep growing them at that rate, in 2018 and beyond. But history tells us that growth never continues at that pace for ever. Furthermore, valuations in some stocks are now higher than when these shares were younger and so had more of their growth ahead of them. The FANGs (and their Chinese counterparts) were in the frontline of 2017’s global equity boom. But many other areas also worked very well, such as Emerging Markets which we got into in September 2017. Therefore, despite the heat in some high-profile segments of the market, growth seems more broadly-based than some commentators seem to appreciate.
Deflationary risks recede, and interest rates rise- finally!
10 years on from the financial crisis, we can now start to finally see the markets approach a “Normalisation” of interest-rate cycles and we do expect central bankers to work on demand sided policies, i.e., monetary and fiscal policy, while there is always a risk of us reaching the end of the cycle. However, we cannot completely go by this and the hawkish stance central bankers take to hike rates based on the unpredictability of a hike. We have had similar false starts before such as that seen in 2015 when they said they will start to hike rates, but they didn’t and only just recently became serious about this, based on current economic factors. It is possibly in 2018 that the market starts to accept that deflation is no longer an immediate threat and that interest rates (both short and long term) have bottomed out. The expectation of ongoing monetary tightening and the withdrawal of liquidity would not be supportive for markets overall and probably not for most ‘traditional’ income stocks.
Throughout 2018, we do expect equity markets to continue to strengthen, however at a slower pace. Most of the current gains being seen in the US markets are driving earnings growth in Europe, Asia and other Emerging Markets. Markets in 2018 are likely to be far less boring than they were in 2017, which was characterised by low volatility and steady rallies in risky and risk-free assets alike. This year, we do expect volatility to pick up and corrections are probable. The markets see 4 main risks this year being (i) a bear market in the US stocks; (ii) a materially strong US dollar; (iii) large rises in core yields; (iv) a sharp slowdown in China, however it is very unlikely that any of these will manifest themselves in this year. Economists and other market makers see a large US equity bear market as an unlikely event, given the strong EPS momentum and solid growth in world trade, which is continuing and is supported by a soft US Dollar. Any short-term spikes in the US Dollar will be tamed by the global nature of the current expansion.
If we were to highlight the major risks facing the European markets, it wouldn’t be Brexit, Trump or North Korea, instead it would be the very expensive growth stocks that every investor owns already, and which need low interest rates to sustain their valuations. It makes no sense to assume that the investment strategies that worked as interest rates were falling (such as buying growth stocks) will keep working as they go up. If interest rates are expected to go up in 2018, we will need to assume that the same strategies will keep working in perpetuity. History would suggest otherwise, noting that nothing in the equity markets works forever. Capital expenditure is expected to pick up. A lack of progress by the Trump administration had put things on hold for 2017 but projects should now be materialising in 2018. With an emphasis on bringing activity back to the US, this capex spend could result in a renaissance in US manufacturing and sustainable development.
For anyone who wants further data to substantiate the position please review the attached Global Economic News Document.
Model Portfolios & Indices
Throughout 2017, equity market indices have shown strong gains, especially those seen in the US which have been driving global growth. We have seen record highs for US stocks with relatively low volatility throughout 2017, which will be challenged and tested in 2018, and may see more market volatility, especially in Q3 and Q4. According to the research our fund managers are conducting, corporate America is expected to have grown its earnings by around 10% in 2017 and given the continued positive economic trends and the expected boost from tax reform, we should see earnings growth of a similar magnitude in 2018. This will drive global growth within our expectations. With our portfolios, these are skewed more towards the ‘normalised’ approach with a higher equity allocation following our December rebalance and should therefore benefit from the global growth cycle.
The data above will not directly correlate to the indices as there is always a delay in pricing because the US markets close significantly later than the European markets and the Asian markets. The data set above reflects the last close and much of the day’s movements will not yet be reflected in the portfolios due to pricing delays. You cannot therefore directly correlate indices to the portfolios. The value of investments may fluctuate in price or value and you may get back less than the amount originally invested. Past performance is not a guarantee of future performance. Performance figures quoted include the fund manager charges but exclude other fees such as adviser, custodian, switch and/or discretionary investment management fees. Unless otherwise instructed and accrued, income is reinvested into the portfolio.
This Day in History
On this day in 1974, President Nixon signed an act that sets a highway speed limit of 55 mph throughout the US. Perhaps inspired more by the OPEC oil embargo over safety concerns throughout the country, this law was passed and is still used in certain parts of the US.
As always have a wonderful week and stay safe.
Jason Stather-Lodge CFP, MCSI, APFS
CEO & Founder
Chartered & Certified Financial Planner
Chartered Wealth Manager