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2017 saw all 45 OECD countries and the major emerging economies in synchronised growth for the first time in 10 years. JBWere examines the impact ‘synchronised growth’ has on markets and what’s in store for investors in 2018.
Politically, the world might have spent 2017 navigating stormy waters but the markets rode above it all to provide some exceptional returns. Importantly, synchronised growth looks set to continue delivering in 2018.
Senior Investment Strategist at JBWere Nick Ryder says that synchronised growth can generate its own success.
“It provides a sense of earnings certainty and reduces the risk of a serious recession, which builds business and consumer confidence,” he explains, adding that the smoother waters also bring the risk of an inflation rise, which could negatively affect markets. This could mean 2018 is the last of the summer wine for investors before inflation causes rates to rise.
“We expect US interest rates to nudge slightly higher in 2018, with US 10-year Treasuries reaching between 2.75 per cent and 3.00 per cent,” Ryder says.
“If it happens gradually, the market will have time to adjust so equities could very well continue to thrive, particularly financials.”
Despite the rosy outlook, Ryder believes there are a few fault lines that investors should watch closely.
The first is China’s pace of economic reform. The IMF recently predicted China’s non-financial debt to GDP to rise to almost 300 per cent by 2022 if the Chinese economy fails to reform.
However, JBWere expects China to step up its pace of reform in 2018, which could cause its own headaches.
“We’re aware that radical economic transformations often cause near-term pain,” Ryder says. “The Chinese property market is already losing momentum and the slowdown could spread.”
The May Italian election is another unknown quantity. A result that could de-stabilise the European Union further is a possibility, as Italy’s two-speed economy has led to increased popularity for protest parties such as Lega Nord and M5S. Fortunately, their Euro-exit rhetoric was dialled down in late 2017 and, at the moment, the protest parties seem unlikely to win at the polls.
While many commentators believe Trump’s corporate tax cuts will boost the US economy in the short term, the total size of its contribution to US GDP growth is underwhelming. The Joint Committee on Taxation calculates it at 0.8 percentage points over the first 10 years while Goldman Sachs says 0.3 percentage points with the increase dissipating after 2020 and then actually becoming a drag on the economy*.
The Australian economy continues to perform reasonably well, supported by infrastructure and housing construction, as well as stronger LNG exports.
However, while full- and part-time employment levels continued to rise in 2017, wage growth has stalled. Rising energy prices and higher mortgage rates on certain types of home loans have led to consumers tightening their spending belts.
JBWere doesn’t see any major domestic changes during 2018.
“The Reserve Bank of Australia expects its next policy change to be a rate rise,” Ryder notes, “but the markets don’t expect it to occur until 2019.”
Australian equities aren’t growing earnings as strongly as international stocks. And while the market has the ability to grow, it is heavily dependent on resource sector earnings, which are dependent on China’s GDP growth.
International equities, and especially US equities, are trading at a premium, which JBWere believes will continue in 2018. Europe and the rest of Asia, including Japan, provide greater exposure than the US to cyclical improvements in the global economy.
With both domestic and global fixed income remaining relatively unattractive, JBWere doesn’t see bond and domestic REIT yields rising dramatically.
Ryder points out that elevated equity and bond valuations suggest investors should consider greater asset class diversification through the use of alternative defensive and growth strategies.
JBWere believes the US dollar could move higher in 2018 and push the Australian dollar towards the mid- to low-70-US-cent level, especially if the US ups interest rates ahead of Australia.
For more investment insights from JBWere, see their News & Insights page.
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