In Scope:

2017 Review & 2018 Preview

December 18, 2017

 

2017 review

 Stock-market records broken

  • A global economy running at full steam, strong corporate earnings, continuing low interest rates and receding political concerns in Europe all combined to support the stock market climate.

  • Despite the strong stock market performance, the euro area market fell short of the peaks seen in 1999 and 2007.

  • The US stock exchange, by contrast, piled record upon record and climbed for no fewer than 13 months in a row; euro area investors, because of the strong euro, benefited only partially from this.

  • Cyclical sectors, with Technology the clear leader, were the positive sectoral outliers. Energy and Telecom Services brought up the rear.
 

Year of the euro area

  • In 2017 everything fell into place for the euro area. Although the uncertainty surrounding the French elections caused some unrest, the feared rise of anti-European forces failed to materialise.

  • Economic growth picked up in all euro area countries. In fact, the euro area outperformed the United States by delivering the strongest growth in the developed markets.

  • The European Central Bank (ECB) rode a perfect race. It lifted its foot only gradually from the accelerator and kept all options open. The only thing it was unable to prevent was a strengthening of the euro, but that was also partly due to the weakness of the dollar.
 

Waiting for Trump

  • Apart from relaxation of a few rules (mainly relating to environmental legislation), President Trump was barely able to implement any items from his ‘Make America Great Again’ programme during his first year of office.

  • ‘Bad Trump’ elements, such as increasing trade protection, consequently failed to materialise. However, the ‘Good Trump’ agenda items, such as the stimulation of the economy through infrastructure projects and more government spending on ‘law & order’, also remained on the shelf.

  • The failure to materialise of ‘Make America Great Again’ measures, combined with a very cautious Federal Reserve (Fed), weighed on the US dollar.

  • The only measure that seems likely to be implemented as the cut in corporation tax.
 

Comeback for earnings growth

  • After the weak years between 2014 and 2016, the high expectations on corporate earnings for 2017 have been fulfilled.

  • In contrast to other years, the forecasts were not downrated as the year progressed.

  • Earnings per share on the World Index rose more than 15% (compared with a fall of 5% in 2016).

  • The euro area, Japan and the (Asian) emerging markets recorded the strongest earnings growth.
 

Central Banks easing back

  • The volatility of the oil price continued to influence the course of inflation in 2017, pushing up inflation at the start of the year especially.

  • Apart from the oil price, inflation remained under control. The central bank targets were barely achieved in the US and not achieved at all in the euro area.

  • The Fed raised interest rates twice in the first quarter, eased back a little in the summer and took action again towards the end of the year. It began reducing its balance sheet in October and raised interest rates for a third time in December.

  • The ECB scaled back its asset purchase programme in March, and in the summer announced that sufficient action had been taken. In October, however, it blew cold again by extending the purchase programme after all, until (at least) September 2018.
 

2018 preview

Turning off the money tap

  • The Fed will continue its policy of normalising interest rates (we are predicting three hikes in 2018) and reducing its balance sheet.

  • The ECB will keep the money tap open until the end of September (30 billion euros per month). The first interest rate rise will follow only some time after the end of the purchase programme.

  • Once the ECB purchase programme has ended, Japan will be the only country that is keeping the money tap open. As this is offset by the balance sheet reductions by the Fed, at the end of 2018 the money tap across the world will be closed for the first time since 2009.

  • Low key rates in developed countries continue to boost the economy (and stock markets).
 

Global economy coming up to speed

  • The planned tax reductions have thrown oil on the fire of a US economy that is already performing strongly.

  • Rising employment and higher corporate investments are also keeping economic growth in the euro area above the projected long-term trend. We have no concerns that the more expensive euro will throw a spanner in the works.

  • The weak link in the West remains the British economy, where higher inflation (due to the weaker pound) is cutting deeply into consumer spending power.

  • Growth in Japan remains fairly strong, supported by a cheap yen and flexible monetary policy.

  • The emerging markets are also joining the global recovery. We do not think the Chinese efforts to make growth less dependent on lending will lead to a derailing of the economy.


Shares remain the top choice

  • Despite the strong returns of recent years (averaging +10% for the World Index in 2016-2017), shares remain the most attractive asset class.

  • The positive economic picture and further strong earnings growth offer the prospect of at least an average year on the stock market, although occasional corrections cannot be ruled out.

  • The risk of negative returns on bonds is very high in 2018. Despite a very slight increase in yields in 2017, the interest-rate buffer remains very small. A limited rise in interest rates will be enough to push returns into the red.
 

Earnings growth supports more expensive valuations

  • Measured by just about every criterion, the US stock market is more expensive today than at any time in the last 20 years. Valuations have also risen in Europe and the emerging markets, but have not reached anything like the extreme levels seen in the US.

  • In itself, an expensive valuation does not undermine the appeal of shares, especially if earnings growth remains strong.

  • With earnings growth projections of 10%, the expectations for 2018 are high, but with a global economy running at full steam they are by no means unrealistic.
 

Nervousness returning

  • The volatility of the stock markets is at a historic low.

  • It is not always clear what drives volatility, but it generally tends to return to the historical average.

  • Possible flies in the ointment for the worry-free climate in 2018 are:
    • the end of the ‘Goldilocks’ scenario (will the synchronous growth of the global economy suddenly be disrupted? Will inflation suddenly turn out higher than expected? Will the money taps be turned off sooner than projected?)
    • vertigo on the equity markets (is the earnings growth sufficient to support the high valuations?)
  • And as always, there are external factors which could disrupt the markets, such as elections in Italy, the crisis in Catalonia, the Brexit negotiations, the rebalancing of the Chinese economy, President Trump’s foreign policy and trade policy, and so on...
 
 
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