A new year of opportunities is unfolding. Global growth is picking momentum. Consumers and industries are optimistic around the world. The obvious risks to this positive outlook are markets running ahead of themselves and the end of monetary stimulus.
Evli’s key expectations for 2018 are:
- It will be another year for equity markets. Robust economic activity supports earnings growth, which boosts equity market returns. Investors have less asset classes where to expect decent returns – equities being one of the few. Alas, equity valuations are not cheap – but not stretched either. We expect around 10% total returns in global equities, which is slightly over their long term average. Nevertheless, higher equity volatility shouldn’t surprise.
- Global growth is good, but without surprises. As 2017 was a year of positive macro surprises and strong growth, there is less room to exceed expectations. Nevertheless, growth will remain good and will be supported by favorable monetary conditions, affordable energy prices and growing economic activity. US growth is approaching its cyclical peak, but a turnaround could still be a couple of years ahead.
- This year’s main macro theme, and possibly a surprise, will be the comeback of inflation. US core inflation is expected to start rising in the spring. Tighter job markets and rising inflation could force the Fed to hike rates more than expected. The ECB is ending its massive money stimulus program next year, most likely in September. Euro fixed income markets will be attentive to the transition of ECB’s monetary policy. So far, the central banks have been gentle in their policy actions.
- Bond markets face headwinds. The positive economic outlook, the comeback of inflation and the end of monetary stimulus, as we know it, pressure yields upwards. Nevertheless, long term uncertainties in productivity growth, impacts of new technologies and demographics keeps the long end relatively capped. The US yield curve will flatten further.
- The search for yield continues in fixed income. The ongoing demand for high yield bonds will produce decent HY returns in 2018, despite more demanding valuations. We may see a prolonged period of tight spreads. Corporate fundamentals are good, M&A activity and operative investments are not yet threatening debt servicing. Quality pockets can be found in Nordic corporate bonds. EM corporate bonds offer ever better quality and diversification in corporate bond investments.
- Favor non-US equities. Europe and Emerging Markets have the best upside potential in 2018, even though the US tax resolution boosts US earnings. Both Europe and EM usually perform well in late-cycle markets. In Europe earnings and margins are still lagging long-term trends, hence a catch-up with the rest-of-world seems plausible for the region. The golden era of technology stocks is coming to its end.
- Our three pillars in equity portfolios are tactical allocation, cash flow strategies and smart beta strategies. One clear risk in this environment is complacency, and one should be prepared to change his mind, when facts change. Cash flow strategies in equity investments offer a solid fundamental ground in a bubbly world. Systematic smart beta strategies don’t guess. They do what one should do, when in doubt.
Text: Tomas Hildebrandt
Tomas Hildebrandt is a senior porfolio manager for institutional clients. He is a member of Evli’s asset allocation team and is also working as a market strategist. Tomas joined Evli in 1996 and has been working in capital markets for nearly 30 years.