Politically and socially, 2017 was a bit of a tough year. Economically though, the last twelve months were pretty spectacular.
Global growth is humming along, and we are finally getting a taste of the vital ingredient that has been missing since the crisis: belief.
The air of optimism about the future has worked its way into markets – the consensus view on the year to come is that the glass is certainly half full, and that there may well be something coming to top it up the rest of the way.
This will be the tenth Year Ahead we’ve published. The very first was written in December 2008, with the FTSE 100 sitting at around 4,000. The tone was, understandably, bleak.
The global economy has come a long, long way since then, and in comparison to our previous versions, the outlook for 2018 is the most optimistic we’ve written…
2018 – Can it meet the hype?
- Expectations for 2018 are bullish. The word ‘recovery’ has been replaced by ‘expansion’ – and the optimism extends out past this year into the next, and the one after that. Investors finally have enough evidence of synchronised global growth to start believing in the long term again. Our base case is that this confidence will create a virtuous circle for the global economy, allowing a normalisation of monetary policy with minimal market impact.
- The key economic variable to watch over the coming year will be wages. We need to see some income growth to keep consumer confidence high, but there is a danger that too much too soon could see central banks panic about inflation, and begin hiking interest rates rapidly. The good news is that this is very much a conventional worry – central banks putting an end to the cycle through interest rate increases is nothing new. The bad news is that a recession is still a recession. Welcome back to normal – it’s never as easy as it seems!
- So what isn’t normal about the world? It seems unlikely that politics will take a backseat in 2018; social media has made populism a Pandora’s Box that is now wide open, with the only question being the location of the next big political shift. The real surprise would be if 2018 marks the start of a swing back towards the centre – the political momentum does not seem to be heading that way at the moment. Expect to see plenty more polarising figures and statements being made.
- If 2017 was the year when everyone expected a negative market surprise, and didn’t get one, will 2018 be the opposite? Whilst it might be nicely poetic, having a good year in markets does not mean the next year will be a bad one. In general, a global expansion is good for stocks. There is always the chance of a nasty shock, but absent that, it could well be that at the end of 2018 we are reviewing another double digit year for equities.
Looking in more detail at the various regions:
Still growing strongly. Everyone has been waiting for the point in the growth cycle where the US is no longer the leader and the rest of the world takes over. We’ve reached a point where the rest of the world has caught up, but given the consumer confidence numbers out of the US, 2018 doesn’t look like the year where it concedes the lead. Indeed, growth elsewhere in the world will add to the domestic US momentum. We could see a 3% GDP growth figure in twelve months’ time.
The political ship doesn’t capsize, but nor does it have a captain. Donald Trump’s second year in office is likely to be similar to his first, with a lot of noise, a lot of golf, and very little action. The interesting part of US politics will be the midterm Congressional elections. Don’t be fooled by the tax bill being passed, the US government remains almost paralysed due to splits in the Republican Party. It wouldn’t take many Democrat victories to further split the House and the Senate.
Corporate earnings continue upwards, some sector rotation. Political gridlock is business as usual for the US, and businesses will indeed continue as usual – which should mean further profit growth, helping to keep the equity market run going. 2018 could be the year that more traditional cyclical sectors such as basic materials and financials lead markets higher on the back of an increase in global demand. At the same time, the massive technology companies that drove the rally in 2017 look like they are going to come into more conflict with regulators and governments around the world. That could mean slightly less stellar returns for the tech-stock dominated NASDAQ, relative to the S&P 500 or the midcap Russell 2000.
Despite the fuss at the Fed, interest rates rise gradually. Expect to see a lot of headlines about personnel changes at the Federal Reserve this year – there are four potential appointments still to be made. Despite the noise, these shouldn’t be too problematic for policy or markets – being a Federal Reserve Governor requires serious academic credentials (unlike being US President). The risk of a maverick is very low.
“Donald Trump’s second year in office is likely to be similar to his first, with a lot of noise, a lot of golf, and very little action.”
A record breaking year for Eurozone growth? Current expectations for 2018 are around 2.2% GDP growth, so there is a way to go – the highwater mark of growth for the currency union was just above 3% in 2006. Growth may not reach those highs in 2018 but it will get close.
Across the core and the periphery, consumer confidence is high, unemployment is still falling and businesses are looking to invest, all of which should maintain the momentum.
European Equities finally outperform US Equities. Even though US growth should be higher than European growth in 2018, this is already priced into markets. The benign global growth environment should see investors find the relative cheapness of European companies attractive compared to the US. Indeed, if the global technology sector does find itself challenged over the next few months, European indices could benefit from having almost zero exposure.
The European Central Bank (ECB) back in the spotlight. Despite having committed to purchase bonds until at least September 2018, the ECB’s policies are likely to be scrutinised, as bond markets question the need for emergency level monetary policy. Whether or not the money printing actually stops is almost irrelevant – the speculation alone will be something to watch out for. In November 2018, Mario Draghi will have only one year remaining as Governor, so also expect to see some focus on his potential replacement.
More political cans kicked. With 19 countries in the Eurozone, there will always be an election to worry about. This year, the attention will be on Italy’s General Election in March, but the atmosphere is far less strained than the 2013 election when GDP growth was – 2% and the banking system seemingly on the verge of collapse. Chances are we still won’t see a strong Italian government forging a bright new future – but that’s nothing new.
Benefiting from the global recovery. Japan is often said to be the last boat that floats in a global growth cycle. With domestic consumer confidence heading back towards all-time highs, the Japanese economy looks well placed to keep expanding this year. Towards the end of the year, we may see a further boost as purchases are made ahead of the consumption tax increase in 2019.
Inflation to tip above 1%. The Yen has been getting weaker, energy prices have picked up, and there are signs of wage increases finally coming through – as there should be, given unemployment rates are at their lowest levels since the bubble burst! All of these factors should see inflation continue its slow upwards grind.
Bank of Japan surprises markets by reducing bond purchases. The Bank of Japan has pumped more money into Japan’s economy (relative to GDP) than any other central bank in the world. It is running out of bonds to buy – so the obvious solution is to stop buying! Waiting for Japanese Government Bond yields to go up has become known as the ‘widow-maker’ over the last two decades, but with yields at extreme lows markets will find it hard to bet against this outcome.
Reasserting regional influence. Having fought and won another election, Prime Minister Abe will be feeling pretty secure in his position. This may be the year we see his nationalistic tendencies come to the fore, in order to prepare Japan for greater involvement in Asia should the US withdrawal continue. If we see increased development of Japan’s military capacity, this could be a further boost to growth, if not to political stability.
UK growth lower than Europe... It is becoming apparent that a pause in business investment over the past 18 months has been a drag on growth, felt most strongly in the construction sector. Short of a swiftly resolved Brexit deal in the first months of the year (unlikely), the Eurozone looks set to grow at nearly 3%, while the UK will be lucky to limp over 2%. 2018 will be the first time since before the Financial Crisis that Europe has grown faster than the UK for two consecutive years.
...but UK companies continue to make profits. The UK remains an open global economy, and so despite the Brexit impact, it will benefit from the boom going on around the world. In addition, consumer sentiment may be given a lift from falling inflation and rising wages, helping the domestically exposed businesses expand.
Pro-trade Brexit becomes the aim. Many of the complications of EU membership have nothing to do with trade – indeed an untethered UK would probably be seeking to join something such as EFTA or the Customs Union as part of its trade negotiations. The benefit of these agreements is that they are not really tarred with the EU brush – EFTA was in fact a British idea! Theresa May’s government could well move towards a solution where exit from the EU is achieved, but the UK remains a member of EFTA. Not quite a win-win, perhaps – but there will be no agreement that leaves everybody happy!
“2018 will be the first time since before the Financial Crisis that Europe has grown faster than the UK for two consecutive years.”
Other Key Markets
China expands international influence. We saw a glimmer of this in 2017, with President Xi Jinping attending the World Economic Forum in Davos – the first time a Chinese Premier has done so. China has been looking outside of its borders for some years now, but with Donald Trump’s White House likely to be focused on domestic issues, 2018 might be the best opportunity so far for Xi to step further into the global spotlight.
China manages its growth transition smoothly. Some forecasters have been waiting for China to have a ‘hard-landing’ for a decade; by which they mean a big miss of the annual GDP growth target. At the National Party Congress at the end of 2017, Chinese officials pulled a nice trick. They removed the target – instead prioritising the well-being of citizens and environmental issues. So, for the first time, China can publish a GDP figure below 6%, and still claim to be meeting its aim. We still don’t expect to see much of a slowdown, but at least some explanation is ready should one occur.
Indian economic and political momentum continues. The shocks to the economic system of demonetisation and the Goods and Sales Tax should work through by the end of 2018. This could lead to fairly spectacular growth figures in India. On the political side, Prime Minister Modi is still immensely popular, and his opposition has no credible leader. The next General Election is in 2019, so rather than structural reform, the next twelve months is likely to see more fiscal giveaways, particularly in the agricultural sector.
South Korea to surge. Global growth has always supercharged the South Korean economy, and this time should be no different, with demand for heavy machinery, petrochemicals and semiconductors set to increase. In addition, the government is also implementing a domestic spending plan, pushing consumer confidence to post-crisis highs. Of course, the risk of a confrontation with the northern neighbours is always there, but mere threat alone hasn’t stopped the South Korean economy over the past 30 years, so it is unlikely to do so now.
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