The next twelve months are likely to see continued synchronised global growth across both developed and emerging markets, says Stephen Mitchell, Head of Strategy, Global Equities at Jupiter Asset Management.
A potential dark cloud is gathering in the form of the US Federal Reserve (the Fed), as the U.S. navigates uncharted waters with the unprecedented combination of quantitative tightening AND rising interest rates. There’s thus a real possibility that the Fed may spoil the party as labour markets tighten. Historically Fed tightening cycles have exposed vulnerable areas of over-leverage in the global economy with negative consequences for asset prices. Global funds therefore need to take a robust approach, investing in areas which are not correlated with economic growth, but benefit from structural growth drivers.
Synchronised global growth to continue into 2018
Global growth looks set to continue in the year ahead as markets reap the rewards of accommodative monetary policy and rate cuts executed in 2015/16. This has allowed for an economic renaissance to gather pace as countries grow in unison, creating synchronised global growth which is normally more robust.
In Europe, Germany has been the engine room of growth, fuelling advancement to its Eastern neighbours and in Southern Europe. In 2018, this economic expansion across the Continent should continue. The UK, however, is in a different cycle, and the risks going into 2018 still look elevated as the government seeks to thrash out post-Brexit trade agreements in a politically fragile environment. From a global perspective, while we recognise there is now real value in UK stocks, we prefer to remain cautious in the year ahead. Global funds continue to hold UK companies such as British American Tobacco (BAT), which is global and where growth is driven by new products not the UK economy.
Emerging markets should benefit from significant number of interest rate cuts
Looking to emerging markets (EM), this year has stood witness to a very significant number of interest rate cuts: Brazil, Russia and India to name a few. These cuts will take between twelve to eighteen months to filter through, which is why it is anticipated that a better 2018 and 2019 will be seen for their equity markets. In fact, for a number of countries, such as Russia, India and Brazil, rates are still high despite cuts and Mexico is at, or very close to, the top of its rate cycle. Heading into 2018 global funds have been gently raising exposure to emerging markets, for example, Mexico where there is value and which has been out of favour since the ascendency of Trump. In EM, positive demographics combined with a significant drop in interest rates should support growth whereas developed markets (DM) are entering a tightening cycle, removing liquidity from markets.
China and India are both of crucial importance to the global economy as their impressive growth benefits companies around the globe. India has grown by a healthy 5.7% in 2017 and the outlook remains bright as a result of Modi’s reforms. China presents a mild potential drag on global growth as it starts to tighten policy, albeit gently. The Chinese authorities are conscious of the country’s high debt levels and reigning in borrowing; whilst at the same time are determined to improve China’s poor environmental standards. Together these two factors could slow the Chinese economy as we enter 2018, with some impact upon global growth. Relaxing policies on housing though is a lever they can easily pull to push growth back up, so this is cyclical more than structural.
US wage inflation needs to remain subdued, staying Fed’s approach
The US outlook is complicated by likely tax cuts which will stimulate the economy at a time when labour availability is already tight – and this could accelerate the Federal Reserve’s view on the need for more rate hikes. Markets have never experienced a period of rising rates and quantitative tightening and the effect it will have globally in 2018 is unknown. Wage inflation has been very subdued which has allowed the Fed to only tighten very gently to date, and it is clear that disruptive trends in robotics, factory automation, artificial intelligence, Big Data computing power and new office software are radically changing the bargaining power of labour. These are all trends that global funds can invest in that will help sustain investment returns, as well as, for example, advancements in medical healthcare technology that should be resilient if the Fed does need to tighten more than expected.
Positive outlook with caveat of quantitative tightening
Overall, the global economic outlook for the year ahead remains positive, although equity and credit valuations do suggest a degree of caution for markets. Thus investing in companies with robust balance sheets and cash-flow, a good attitude to returning cash to shareholders and resilient sales drivers is a sensible approach. Will the Fed have ended the global growth party by the end of 2018? As there has never been quantitative tightening before it is new territory, but whilst liquidity injections by central banks will still be positive it will have slowed down the degree going into global markets quite significantly. With this in mind, it is wise to invest in companies that are resilient in 2018.
In 2017 we forecast that inflation would start to pick up in DM, with single digit returns from equity markets and a more positive outlook for EM equities. Indeed the US did start a rate tightening cycle but inflation was more subdued than we expected allowing rather higher returns from DM equity markets. EM equities did outperform as predicted. For 2018, the interest rate and economic drivers for EM still look positive and equities should deliver positive returns, but we are highlighting that for 2018 a subdued (wage) inflation in DM needs to persist or a less benign rates environment for equities will evolve.
Stephen Mitchell - Head of Strategy, Global Equities - Jupiter Asset Management