2018 Global Market Outlook: Running with the bulls
Will the global growth momentum of 2017 carry over into next year? Is there a risk of a pullback in the short term? See what our strategists' views on global investment markets and economies are for the year ahead.
Could 2018 be a year of two halves?
As 2017 winds down, we see some encouraging developments that could help extend the global bull market into 2018: The U.S. Federal Reserve (the Fed)’s leadership is moving to the safe hands of Jerome Powell, tax cuts are progressing through the U.S. Congress, and Europe has navigated most of its political landmines. The global growth momentum we witnessed in 2017 seems likely to persist into next year. However, many of our sentiment indicators also point to a near-time risk of a pullback. Could 2018 be a year of two halves?
2018 – year of the U.S. recession?
The critical issue we foresee is the timing of the next U.S. recession, as this almost always results in an equity bear market.1 The U.S. still dominates global markets and is further advanced in its cycle than other economies, which means that most scenarios for 2018 are likely to be driven by the U.S. By next April, this will be the second-oldest U.S. economic expansion on record. Two weeks ago, I pulled together my three scenarios. Remind yourselves here.
The Business Cycle Index (BCI) model
The BCI model puts the probability of a U.S. recession in the next 12 months at around 25% - a high, but not alarming percentage, given the age of the expansion. This probability, however, could easily rise through the year, if, as we expect, the Fed tightens another three times in 2018.
Euphoria: Still to come?
Sentiment is our best guide
There’s an old saying that bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. The phase we have yet to encounter this time is euphoria. Sentiment, from our investment decision-making process of cycle, value and sentiment, provides the main guide to this. Today, sentiment seems complacent and overbought, but not euphoric.
Could a Fed mistake bring markets down?
Bull markets don’t have to end in euphoria
As another market saying holds, they can be killed by the Fed. One of the key recession-risk issues is working out when Fed policy becomes restrictive. It’s entirely plausible that a couple more Fed funds rate hikes could turn policy restrictive.
We will be monitoring the yield curve closely. This is one of the key inputs into the BCI model. The yield curve has inverted before every recession over the last 50 years. The spread between yields on 10-year and 2-year Treasuries has narrowed from 140 basis points, when the Fed started tightening at the end of 2015, to 60 basis points in late November.
China in 2018
Our 2018 annual outlook overview is very U.S.-centric. It's worth asking whether there are any global factors that could trigger a global bear market. The main candidate for a non-U.S. shock is China. We're not expecting a China-sparked crisis, but high debt levels are a risk and outgoing People’s Bank of China governor Zhou Xiaochuan recently warned about the risk of a "Minsky moment”.2
The recent Communist Party National Congress entrenched the power of President Xi Jinping, giving him the authority to pursue his reform agenda in his second five-year term. Near the top of his list is deflating the debt bubble. Chinese central bankers have many more levers than their counterparts in developed markets, so the likelihood is they will be able to engineer a gradual deleveraging. But tightening credit in a high debt economy is a fraught exercise. China’s monthly money and credit growth statistics will bear close watching for signs of a sharper-than-expected slowdown.
Neither bullish or bearish
In sum, we’re not especially bullish or bearish about the year ahead. 2017 delivered better returns than most industry analysts expected, but the cycle is old and the U.S. Federal Reserve (Fed) is about to step up the pace of rate hikes.
Our 2018 outlook view in one sentence?
Equity markets may push higher over the first part of the year, before facing headwinds later in 2018, as markets factor in rising risks of a 2019 recession.
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1 A bear market is defined as a 20% fall in equity markets. The average S&P 500® Index decline in the six bear markets since 1968 was -42%.
2 A Minsky Moment refers to a sudden collapse of asset prices after a long period of growth, sparked by debt or currency pressures. The theory is named after economist Hyman Minsky.