2018 Outlook: Big Bang or Steady State?

2018 Outlook: Big Bang or Steady State?

LOcom_AuthorsAM-Salman.png   Salman Ahmed
Chief Investment Strategist


LOcom_AuthorsAM-Arnaud.png   Charles St Arnaud
Senior Investment Strategist


LOcom_AuthorsAM-Salt.png   Jamie Salt
Graduate Analyst


In 2018 central banks across the globe will begin to withdraw the multi-trillion dollar support they have been injecting into economies for the past decade. How will economies and financial markets fare?

We expect the current “goldilocks” scenario – broadly solid economic growth and subdued inflation – to continue into the first half of 2018. Economies are on solid footing for a continuation of this “steady state,” in our view. But risks of a “big bang” in the form of heightened volatility and sharply-revised asset valuations are far from absent, especially as central banks shift course more decisively. Investors would do well to balance their pursuit of returns with the goal of building safety into their portfolios, as the current business cycle matures further. 

What are the risks to the steady state of low inflation and strong growth?

  • Upcoming shifts in monetary policy in major economies will be key, in our view. Specifically: how will markets react to central bank-provided crutches being removed? A lot depends on how skilfully central banks communicate their intentions, and on how the actual pace of interest rate increases compares with market expectations (specifically for the Federal Reserve). Furthermore, if inflation returns with a vengeance, central banks risk being massively behind the curve.  
  • Also look out for: China’s slowing credit stimulus measures; North Korea vs. Trump – a significant binary risk; rising trade protectionism; and, more locally, Brexit.

Our value calls

  • We continue to believe that there are good investment opportunities in emerging markets and Europe, given attractive valuations and stronger fundamentals, in our view.
  • We are even more cautious about duration risk in advanced economies given the prospect of rising interest rates further weighing on bond market returns.

What does it mean for investors?

With starting bond yield levels so low in advanced economies, any turn in the business cycle means that bonds now provide a much lower capital buffer to equity downturns compared to the past. We believe this makes a strong case for explicit drawdown management techniques in portfolio construction, especially in a balanced portfolio setting.

Fractured bond market liquidity is an ongoing challenge that is gaining more attention; we believe investors need to build quality-focused portfolios in a low-turnover setting and to move away from market cap benchmarks (which reward leverage by design).

Finally, as evidence mounts that climate change is impacting real economic outcomes, the effect of climate change on both long-term economic growth and, by extension, investment returns, and the role investors can play is increasingly in focus.

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