Citywire Selector’s Think Tank series is a showcase of leading strategists outlining what topics are dominating investment thinking at major private banks and asset management companies.
Here David Lafferty, chief market strategist at Natixis Global Asset Management, believes the coming 12 months will be crucial for global growth ambitions and long-term returns.
2018 is shaping up to be a pivotal year for global investors. This coming March would be the ninth anniversary of this bull market, with global equities already up over 200% since March 2009.
But the high returns and low volatility that have characterized this rally are less likely to be sustained going forward. Here are the key themes we’re watching that highlight why 2018 may be an inflection point for global markets.
First, the major central banks are beginning to pull back. The US Fed is raising rates and reducing its balance sheet. In Europe, rates are likely to remain low, but the ECB has begun tapering asset purchases. Similarly, we question whether the Bank of Japan has an unlimited appetite for QE.
By some estimates, central banks have created as much as $6 trillion in excess liquidity which may eventually be withdrawn. This a mighty big balloon that central bankers need to deflate very slowly. The downside risks of this process are unknown.
Second, geopolitical events may be coming to a head. In the UK, the fallout from Brexit has been somewhat hypothetical, but with the March 2019 deadline looming, it’s about to get real.
In the States, the eventual success (or failure) of President Trump’s controversial tax reform plan is likely to either goose animal spirits or leave investors feeling flat.
Risks are growing in Asia, too. With China’s Communist Party Congress in the rearview mirror, Xi’s growth versus reform balancing act will be put to the test while North Korea’s open-ended aggression may have to be addressed militarily. The common thread here is a shift from conjecture to reality that will test the prevailing low volatility regime.
Third, and perhaps most important, is that few if any broad asset classes are cheap. Equity valuation metrics of all stripes are somewhere between extended and extreme. In the bond market, base sovereign yields along with most credit spreads are near historic lows. At these valuations, there is little margin for safety, even in a broadly diversified portfolio.
However, pushing back against these three headwinds is the underlying fundamental strength of the global economy. For the first time in over a decade, we are experiencing a synchronized reflation where the US, Europe, Japan, and emerging markets are gaining traction simultaneously.
As a result, corporate earnings have been improving – underpinning equity gains and corporate credit quality. Broad market gains to risk assets in 2017 show that investors are willing to ignore the headwinds as long as the global economy keeps chugging along.
Continued global growth will likely provide positive but uninspiring returns for stocks and bonds in 2018. But this doesn’t tell the whole story.
Extended valuations, tighter monetary policy, and rising geopolitical tensions create a deteriorating outlook for risk-adjusted returns. At some point, there will be a day reckoning. Investors would be wise to ride the global reflation wave cautiously.