OUTLOOK

2018 Global Market Outlook - Q4 update: Maximum pressure

The U.S. Federal Reserve (the Fed) is settling into a quarterly tightening routine that could see the federal funds rate rise above 3%. Even so, the upside for the U.S. dollar looks limited given its expensive valuation and crowded long positions. We believe a pause in the dollar uptrend should bring respite to beleaguered emerging markets.

Executive summary

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Trade wars are escalating and the Fed is settling into a quarterly tightening regime. We believe pessimism on Europe is overdone. Emerging markets appear attractively priced and oversold, but may not rebound until it is clear the U.S. dollar has peaked.

Maximum pressure

Markets are adjusting to U.S. President Donald Trump’s aggressive trade war stance, and it’s been another tough three months for emerging markets. The challenging questions to answer are how much further trade tension will rise and its impact on trade, economic growth, corporate profits and inflation. Wage pressures in the U.S. are finally picking up and this is being reflected in a slightly more aggressive outlook for the Fed.  

Our cycle, value and sentiment investment process is holding us at a broadly neutral weighting on global equities. The process favors Europe and Japan over the U.S., although this gap has narrowed as positive price momentum supports U.S. sentiment. We like cycle and value for emerging markets, but are waiting for a stronger sentiment signal from oversold indicators. Inflation pressures mean the cycle is becoming a headwind for government bonds, and we think the U.S. dollar has limited upside.

Paul Eitelman sees strong U.S. economic growth and strong corporate earnings coming at the price of a more assertive Fed. Recession risks appear low for now, but he expects the clock will start ticking once the yield curve becomes inverted.  

Andrew Pease argues that the pessimism on Europe is overdone. The risks that dominated the past quarter seem to be getting smaller, the economy is likely to beat low expectations, and earnings forecasts have potential for upside revision.

Graham Harman and Alex Cousley agree that trade war uncertainty adds a note of caution to the Asia-Pacific outlook, but think that most of the bad news is now known. They expect China stimulus to largely offset tariffs and see inflation pressures slowly starting to build in Japan. 

Van Luu and Max Stainton reiterate their view that the U.S. dollar rally is running out of steam. They believe rising Fed rates are dollar supportive, but that the greenback is expensive and speculative investors are very bullish, which is usually a good contrarian sign.

The U.S. business cycle index model estimated by Kara Ng and Abe Robison continues to signal that recession risks are relatively low for the next 12 months. Their model for U.S. equities versus fixed income favors equities, with the momentum component providing the strongest support.

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