It was always going to be a self-fulfilling prophecy that 2018 would turn out nervier for investors than the near-soporific 2017. Uncertainty is on the rise and lots of investors seem inclined to take their profits after the good years on the stock market. We look here at the questions and doubts that are currently keeping investors awake and at how KBC views these developments.
Isn’t waning business confidence a sign that economic growth is beginning to falter?
- The euro area in particular surprised friend and foe alike in 2017 by staging a robust and broadly based recovery. The period of accelerating economic growth is now behind us, but that’s not to say that the economic engine has halted. Confidence indicators (PMIs1 ) self-adjust and revert to the mean. When levels are very high, in other words, the likelihood of a decline is greater on average than that of a further increase. Stock markets often take fright when these indicators ease back from their peak levels (‘roll-overs’ as such moments are called), but when confidence indicators stabilise (or rise again) a recovery tends to ensue pretty quickly.
- Euro area confidence indicators (a PMI of 56.6 for the region’s industry and 55 for its service sector) are still at levels consistent with economic growth in excess of 2% year-on-year.
- On top of this, the US economy is enjoying a substantial reduction in taxes, which is bound to have an effect in the second half of the year. In other words, while the economic engine might not shift up another gear, it is still nicely revved up.
PMI = Purchasing Managers’ Index: an indicator of business confidence and hence of economic growth. A figure of 50 represents a neutral level, while one below 50 indicates a contracting economy and one over 50 economic growth.
Is a global trade war coming?
- President Trump is shaping up to fulfil another of his ‘America First’ promises, namely that of increased protectionism. The announcement of tariff increases on imports of steel, aluminium and Chinese products rekindled fears of a global trade war. The doomsday scenario, obviously, is that measures and counter-measures will escalate, with everyone ultimately losing. It is precisely because no one can win a trade war that we do not expect things to go so far. Developments in recent days confirm our sense that all this is very much a Trump negotiating tactic to engineer a strong opening position. Mexico, Canada and Australia, for instance, were exempted from the new tariffs on steel and aluminium imports almost immediately, followed by South Korea and the European Union. Things moved even faster in China’s case, with negotiations beginning almost immediately.
Doesn’t the Fed risk stepping on the brakes too hard?
- The freshly installed chair of the US central bank, Jerome Powell, hasn’t allowed any of this to throw him off his stride. The Fed raised its key rate last week and Powell also made it clear that he wants to take further steps in 2018. A fresh wind is clearly blowing through the Federal Reserve: the new chair seems less hesitant than his predecessor, Janet Yellen, who often kept things extremely vague and cautious. The fact that inflation has yet to reach the desired level is no longer seen as a reason to hold back. We totally agree with that! The US economy is doing very well, as demonstrated once again by the most recent labour market figures: no fewer than 313 000 new jobs were created, even though unemployment is already historically low. If the Fed had put off acting any longer, it risked being overtaken by events. What’s more, US ten-year bond yields currently stand at just 2.8%. This means that real interest rates are positive but are unlikely to hold the economy back to any significant degree. The Fed might have taken its foot off the accelerator, but it has yet to apply the brakes. Not to mention the European Central Bank (ECB), where they’re still pondering how quickly to ease back on the gas.
Is the tech bubble bursting again?
- The technology sector, lastly, is in the eye of a storm right now. Share prices – led by heavyweight Facebook – have fallen sharply. The dominant position of several tech giants had been questioned for some time, but the situation grew more serious with the news that data from numerous Facebook accounts has been misused. Meanwhile, the European Union wants to tackle the unequal taxation of traditional companies and these worldwide tech giants. Global digital players of this kind have skilfully exploited the various tax regimes with the result that a general sales tax has been proposed in response. The tech giants face bills that will swiftly run into hundreds of millions of dollars.
- The technology sector has been racing ahead in recent years and we weren’t the only ones to suffer a little vertigo in recent weeks. We lowered our sector recommendation to neutral and scaled the tech position back in our equity strategy. All the same, anyone comparing the present situation with the bursting of the dot com bubble in 1999–2000 is overlooking the crucial element of profit. The technology sector back then was an extremely promising niche, but very little was generated in the way of corporate earnings. Things are different now, with substantial profits recorded quarter after quarter (+20% in the fourth quarter of 2017), plus the fact that a lot of these tech giants boast immense cash reserves. And in spite of all the newspaper headlines, technology is the only sector to post a positive return this year.
A great deal of good news found itself priced in last year, and fearful investors are holding their breath now that this ‘good news show’ seems to have run its course. This is understandable, but we view it chiefly as a return to a more normal stock market situation, in which good periods alternate with bad ones. However, there is no reason whatsoever to assume that the economy has ceased to be the principal equity market driver. A strong economy still translates into rising corporate earnings, which boosts share prices. It’s now mainly a question, therefore, of awaiting the next results season for fresh confirmation of this. We see little reason to expect those results to be disappointing: producer and consumer confidence levels, industrial output and retail sales all point in the direction of a further increase in corporate earnings. This ought to provide investors with a little reassurance. We’re keeping a close eye out, but continue to overweight shares in the KBC Investment Strategy(*).
(*) The investment strategy described in this document relates to all investment funds (undertakings for collective investment) managed by KBC Asset Management NV, which make explicit reference in their investment policy, as laid out in the prospectus, to KBC Asset Management’s investment strategy. The stated strategy is not, therefore, altered in the case of other investment funds, the investment policy of which does not refer directly to KBC Asset Management’s investment strategy. It is possible that these investment funds are managed in a way that differs from the investment strategy. You should always read the prospectus and the Key Investor Information Document for the relevant investment fund.
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