By Ben Kumar, Investment Manager, Seven Investment Management
Global growth can easily be described as ‘humming’ and the world seems to have confidence in that growth, be that trade led or domestically driven through consumption. It’s also synchronised – it’s taking place in each of the major regions of the world, which is even more positive for financial markets.
Here at 7IM, we are cautiously optimistic about the future. We are positive, but perhaps less so than others seem to be because of the process which 7IM follows to manage money – making sure that we bear in mind the potential for markets to go down as well as up. So, we consider the many tail risks that are inevitably always present e.g. the negative effects that stalled Brexit negotiations have on the value of Sterling; the implications that cessation of trade between the US and some Asian economies could have on stockmarkets, etc.
In 2016, it was political surprises that largely affected markets, albeit mostly for a short time. In 2017, the surprise was…there was no surprise – despite a number of incidents that one might have thought merited a reaction!
2017’s growth is also setting up a good base case for 2018. And should the forecasts pan out, the one main difference to last year’s conversations could be wage growth.
This is important because increases in wages can impact interest rates. If companies spend profits on capital expenditure and options to improve productivity versus improving pay packets, it could help keep a rein on inflation. This would, in turn, assist central banks who could steadily raise interest rates in small increments. This scenario would be very good for equities, and reasonably nonthreatening to fixed income assets – as long as central bankers can continue to keep the market informed well ahead of any rate rises. Any inflation from wage growth, and other price increases more broadly, could push central bankers to have to hike rates more quickly. Both bonds and equities would face challenges in this situation.
Aside from this concern, it could well be that at the end of 2018 we are reviewing another double digit year for equities around the world. For seven economies though, there is more detail to cover:
Wrangling over the Brexit negotiations will act as a drag on UK growth, which will be fortunate to reach 2% GDP growth. As such, 2018 looks likely to be the first time since pre-2008 that the Eurozone has grown faster than the UK for two consecutive years. UK companies though can continue to post profits, and consumer sentiment may be lifted by inflation dropping back and increases in wage packets – helpful since some 70% of our GDP is driven by the consumer.
The Eurozone’s GDP growth path should carry on and its stockmarket gather momentum to mirror sentiment in the US, particularly as markets have not completely priced in better business investment plans, increasing consumer confidence and lower unemployment. Investors are finding that European companies are relatively cheap and attractive in comparison. Meanwhile, if the tech sector does find that it is no longer leading the charge, European stockmarkets could benefit since they have almost no exposure.
US consumers have led the world out of the recession and its economy is expected to retain its advantage. The more traditional, cyclical sectors (e.g. basic materials, financials) are expected to overtake the technology stocks that drove much of the market performance in 2017, but are now in conflict with many governments and regulators due to their inability to police their content feeds. That could mean that they see slightly lower returns although this would affect the tech-dominated Nasdaq 100 more than the S&P 500 or the broader still Russell 2000.
The Yen has been weakening, energy prices have picked up and there are even some signs of pay increases coming through, which is as it should be since unemployment is now at its lowest level since the 1989 bubble burst. The country is often said to be the last boat to float in a global growth cycle, but with some inflation being recorded and domestic consumer confidence back at notable levels, Japan 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.
Meanwhile, the Bank of Japan could finally start to reduce its bond purchases having pumped more money – relative to GDP – into the domestic economy versus any other central bank. And it would make sense given it is running out of bonds to buy.
Over the last decade, many a forecaster has been stating that the Chinese economy will have a ‘hard-landing’ and miss their annual GDP growth target by a wide margin. However, the 2017 National Party Congress saw Chinese officials perform a bit of a bait-and-switch, removing targets completely! Instead they have prioritised the well-being of their citizens and environmental issues. This enables China, for the first time, to publish a figure of around 6% for GDP and still make the claim that it is meeting its goals. However, we don’t anticipate much of a slowdown.
2018 should see any final shocks to the economic system of demonetisation and the Goods and Sales Tax work their way through. This could leave India in the position to see some fairly spectacular growth figures. The political landscape looks uneventful given Prime Minister Modi is still incredibly popular, and the opposition still has no credible leader. With the next general election taking place in 2019, the coming twelve months are likely to see more fiscal giveaways, particularly in the important agricultural sector, rather than structural reform.
While the soon-to-start Winter Olympics will likely have little impact on this trade-led economy, the global growth story – which has always supercharged the local economy – should kick in. And particularly as any increases in demand for heavy machinery, petrochemicals and semiconductors comes through. In addition, the government is also in the midst of effecting a domestic spending plan, which is pushing consumer confidence to post-financial crisis highs. Of course, there is a risk that confrontations with their northern neighbour steps up – although here the Olympics may actually help – but that threat hasn’t stopped the South Korean economy for over 30 years now, so it is not likely to start now.