CIO - Investment Outlook - Q4 2017
The global equity bull market will shortly celebrate its 10th birthday with investors entering 2018 more bullish than at any stage during the past 10 years. I am generally happier when the consensus is more worried than happy which is not the case today!
While I remain constructive for coming quarters at least, I believe 2018 will be a much tricker year to navigate than 2017 and am conscious that running with bulls can lead to eventually being trampled upon!
The fundamental factors supporting a positive outlook include many stock markets at cycle highs, a very robust global economy forecast for 2018, even stronger forecasts for earnings growth and seemingly lessened political concerns. Thus we have the goldilocks combination of strong growth combined with benign inflation. Central banks remain the supporting act by generally maintaining low interest rates which when combined with quantitative easing are helping to keep this party going.
- There are however plausible scenarios that can upset this and cause market wobbles:
- A world economy that is even stronger than expected, led by the US. Such an overheating scenario would lead to a more rapidly rising interest rate environment which would unsettle markets.
- A meaningful change in global trade agreements, again most likely emanating from the US. Current NAFTA renegotiations need to be monitored and could get nasty.
- Probably unlikely, but an unexpected slowdown in economic growth. Expansions may just die of old age after 10 years.
- The nasty one! Inflation- the ‘dog that hasn’t barked’ finally takes hold in a meaningful way and could unsettle all asset classes.
Asset class outlook:
My central scenario does forecast further upside from here but with the likelihood of more volatility. I do not foresee an imminent risk that would lead to a deep sell-off in markets but as we enter the second half of the year risks should increase and therefore more potential for equity market volatility.
With equity markets at cycle highs there are undoubtedly risks and excesses lurking within the global economy and asset classes. I believe it is prudent for investors to reposition their portfolios and ensure adequate defensive positioning. While aggregate valuations of equity markets are above historic averages it is very interesting to note that the dividend yields available are still very attractive compared to bond or cash yields and I would also focus increasingly on the quality of company fundamentals when investing.
Some excesses I would highlight:
- Increased corporate leverage (funding share buybacks)
- Excesses of valuation within markets e.g. Technology stocks
- Speculative crazes e.g. bitcoin
All the more reason to at least position for a style and sector leadership rotation within equity markets I believe.
Government bonds should struggle badly in most of the scenarios I have outlined. Absent a risk ‘event’ e.g. political crisis or unexpected slowdown, it is difficult to be constructive.
To conclude, the fundamentals remain supportive for further gains in global equity markets but expect a trickier and more volatile outcome than consensus. A year to focus on strong stock picking fundamentals and don’t forget we will soon celebrate the 10th birthday party in early March! We don’t see this as the end of the cycle and do see value within equity markets that can lead the next phase. Bonds look unattractive and should struggle.
Noel O’ Halloran, Chief Investment Officer
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