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08 Dec 2017

2018: Little to gain, lots to lose?



After all the market exuberance of 2017, what’s next? A series of record highs leaves everything feeling a bit “toppish” as we end the year, especially with central banks heading for the QE exits.   

Global equity valuations: reaching a ceiling? 

Global equity valuations: reaching a ceiling?

Source: World Federation of Exchanges, OECD, and national sources. Data as of Sep-2017 (there is a delay in the publications of World Federation of Exchanges). Countries in the sample are US, Japan, Germany, UK, Switzerland, South Africa, South Korea and Taiwan.

We’re not calling a crash, not yet anyway, but complacency could be dangerous despite seemingly synchronised global growth. After all, equity market volatility has dropped below that of bonds for the first time ever this year.

Whether you’re a bull readying for one last run or a bear just waking from hibernation, we’ve got you covered. 


What’s on your horizon?

Here’s a quick summary of the themes we expect to see moving markets next year:


1. QE exit strategies    

We are, finally, “nearing normal”, with central banks set to move further away from their super accommodative policies. Illiquid, expensive assets could suffer – especially in yield, and especially if global growth does peak in the latter part of 2018.

QE exit strategies mean it could be time to consider preparing your portfolio to dampen the effects of certain events – like rising inflation and rates, market volatility and currency movements. The fairytale could finally be coming to an end. 


2. Finally, a fiscal push!    

It’s not all doom & gloom by any means – there are opportunities if you are agile enough to seek them out.  True, there may not be much upside for broad equity indices, especially in the US. But one of the grand global themes for 2018 will be the rise in CAPEX, whether in Europe, the US or Asia. Companies are more willing (or more incentivised) to invest more of the cash they’ve been hoarding in recent years and that could have its benefits.

Tax reform in the US will add to the momentum. Overall, the bill should boost the dollar (albeit relatively briefly) and equities and push up bond yields. In the short term, winners could include small-caps, retail, and possibly financials – although much could already be priced in. Highly indebted companies will however struggle with the limits imposed on interest deductions. Trump’s track record on political management isn’t great, meaning these benefits may be fleeting so you’ll need to be fleet of foot.

In fact, adopting a more nimble approach & selecting the areas set to do best may be more rewarding than holding firm to existing allocations. All this investment could bode well for commodities and infrastructure as well as sectors like construction and technology for example. 


3. Exploiting Europe’s differences  

Differentiation and divergence will become more apparent between markets as well as asset classes. The US recovery is maturing, and all eyes will be on signs of a possible slowdown as we move through 2018. The recoveries in Europe and Japan have room to run yet.

A word of caution though - European markets are now back in line with their long-term averages, so it’s time to dig a bit deeper and support key themes like the recovering consumer and financials. Banking sector risks may be subsiding, but there are others on the horizon.  Politics is still crucial, with the potential fall-out from Catalan elections, Italy’s own election and Brexit all in focus. There are issues in Germany too.

For all that, “Macronomic” progress, the likely need for stimulus spending to secure a coalition in Germany and the general recovery story keep us keen. We favour France and Germany, given potential ECB policy changes and political gridlock cloud the outlook for Italy and Spain. The FTSE 100 faces its own Brexit battles. We do however expect fears to fade and for risks to migrate to the US over the course of H2.


4. Firing Asian arrows​

In Asia, Japan’s improving structural story keeps us positive on the land of the rising sun – especially given the likelihood of another four years of Abe’s loose policy mix. Meanwhile, Xi Jinping’s ever stronger grip on power in China seems to guarantee stability. We can’t see Chinese equities having quite such a stellar year though. Emerging Asian markets should benefit once the dollar resumes its downwards trend. We like Korea and the ASEAN region; in part because they add an element of protection should markets re-correlate in the wake of any US equity correction. We are less positive on India and Taiwan for now.


5. Bond yields to rise​

When it comes to bonds, there’s not much to gain either. Yields are likely to rise everywhere from here (although we’re not calling a market implosion!), but 10yr US Treasuries may still be something of a safe haven. Credit – notably high yield - looks expensive and unappealing. We do however like breakeven stories, starting with the US late this year, early next. Our support could migrate to eurozone issues late in 2018.

Watch this space for much more on these themes and the way to play them in January. Until then, thanks for reading, and seasons greetings! 


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