The pace of significant political and economic events seems to have picked up over the past couple of years, and there is every indication that this will continue next year too. Without a doubt, these events can be seen as aftershocks of the financial crisis, and it is therefore quite reasonable to expect these will continue into next year.
In the US, President Trump’s appointment of Jerome Powell to replace Janet Yellen as Chair of the Federal Reserve was greeted with relief all round. In response, US Treasuries went up, despite strong economic growth and a higher than expected proposed tax cut of $1.5 trillion. With net debt of $16 trillion, what’s another trillion more? So far as US interest rate policy is concerned, it now looks like one more increase this year and three or four next, returning rates to a more normal 2.5%, if all goes to plan.
In late October, the European Central Bank decided to extend quantitative easing for a few more months than expected, despite respectable growth and signs of inflation. The President of the Bundesbank expressed his concerns about too much support having adverse consequences in the longer term, but was ignored by investors, who sold the euro and bought both equities and bonds. It is interesting to note that monetary policy outweighs political strife in Spain, although perhaps it is early days for this particular crisis.
The US, China and Japan, together with the EU, are all moving ahead helped by supportive monetary and fiscal policies. But what next? We might start to suffer from too much of a good thing at some stage during 2018, and see inflation driven higher by too much demand and not enough supply. If this happens, we will look back at 0.25% interest rate rises with wistful affection. For now, however, the present seems good enough.
In the UK, despite doubts about the stability of the British Government at a time of mounting Brexit uncertainty, a survey of UK recruitment consultants reported both an increase in permanent placements, and also that these recruits were able to secure higher pay. A Bank of England survey concurred: it seems that those with the right qualifications are in short supply and so can ask for higher pay. As employers look to hold onto their staff, so pay increases are being considered ahead of an expected rise in inflation.
Over the decades, we have become used to making decisions based on a western framework. Since the financial crisis, this has become an increasingly risky assumption. The centre of gravity of the global economy is shifting and, as it does, we can see the growing influence of non-western money, where decisions are being made using a different rule book. Unsurprisingly, perhaps, the top two performing asset classes so far this year are the MSCI Frontier Markets (26.7%) and MSCI Emerging Markets (23.4%) (source: Datastream, YTD as at 9th November 2017), with the growth forecasts for Emerging Markets and China outstripping all other regions.
In the Far East, North Korea’s missile rattling continues to grab the headlines, while its neighbours go about their business. In China, we have seen President Xi Jinping confirmed in power for the foreseeable future, while managing a transformation of the country’s prospects. The mandate from on high is now for ‘balanced growth’, rather than ‘growth’, which suggests that economic policy will now be directed towards achieving sustainability rather than debt-fuelled growth at any price. It is what the Chinese are good at: combining change with stability. Japan continues its corporate renaissance, so that 60% of earnings now come from abroad and innovation has been brought in. Earnings growth is largely responsible for the market re-rating that we are now seeing in Japan.
In the Middle East, the long-simmering tension between Saudi Arabia and Iran, the two key players in the region, has suddenly escalated. Saudi Crown Prince Mohammad bin Salman has locked up senior members of the establishment, disturbing the carefully cultivated equilibrium we have come to expect of the kingdom. He has also forced the resignation of Lebanese Prime Minister Saad Hariri, for reasons not declared but likely related to the proxy wars going on in Syria, Lebanon and Yemen between Sunni (Saudi backed) and Shia (Iran backed) forces.
The importance of these dramatic developments is that approximately 20% of global oil production is transported through the Persian Gulf, which separates Saudi Arabia and Iran. As yet, it seems the markets have ignored the increased geopolitical risk that these events represent, though this could now more easily change, with real implications for the global economy.
Barring a political shock, monetary policy error, investor over-confidence or a credit event, the outlook for 2018 can be regarded as positive. The bull market scenario is based on economic fundamentals that still look supportive; corporate valuations and profitability are reasonable; and, with equities attractive relative to other assets classes, investor confidence is increasing modestly.
At some stage, economic growth with low inflation might be too much of a good thing. As the end of 2017 comes in to sight, against a backdrop of relatively high stock valuations, rising interest rates and innovation disrupting established business models, due regard must be given to the basics of investment life: with deposit rates still close to zero, not being invested is bad for your income; innovation creates winners and losers, even if index volatility is low; and, most importantly, long-term investment success comes from having the flexibility to meet the challenges of a changing world.
Investors should remember that the value of investments, and the income from them, can go down as well as up. Investors may not recover what they invest. Past performance is no guarantee of future results.
Any mention of a specific security should not be interpreted as a solicitation to buy or sell a specific security.
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