Economic Outlook for January 2018
Last year the S&P index gained 19%, but in Europe the Stoxx 50 recorded a more modest +6.5%. Asia, once again, saw some of the more spectacular price moves with the Hang Seng jumping by 36% and the MSCI Asia Pacific index increasing by nearly 29%. After such a favourable year for equities investors could be forgiven for asking what possibly could disturb the current momentum in share prices. There are a number of equity market drivers which could potentially deteriorate in the course of 2018, such as trade relations between Europe and the US, potential policy misjudgments by central banks (by raising official interest rates too high and/or too soon), deteriorating domestic political landscapes in a number of crucial geographies (such as Brazil) and, importantly, a shift in equity risk perceptions by market participants.
Compared to other starts to the year, however, the current reward /risk trade off compares favourably in a historic context, with the only possible caveat being the recent political confrontations in Iran.
Global GDP Growth
Source: IMF World Economic Outlook, October 2017
The latest World Economic Outlook from the IMF starts as follows: “The global upswing in economic activity is strengthening, with global growth projected to rise to 3.6 percent in 2017 and 3.7 percent in 2018. Broad-based upward revisions in the euro area, Japan, emerging Asia, emerging Europe, and Russia more than offset downward revisions for the United States and the United Kingdom”. This broadening and deepening global economic upswing has continued to drive global equities and, in the absence of unexpected shocks, there are currently no major factors disturbing the positive global momentum.
After two profitable stock market years the outlook for equities therefore remains favourable – although, arguably, the “easy money” has possibly already been made. At the start of 2018 the political landscape continues to be relatively calm, thereby adding to a benign investment climate for the global economy. Global GDP growth, meanwhile, is building on the positive momentum carried over from 2017 and is currently running at the upper end of forecasts, possibly touching 4% in the course of the year, according to the IMF. So, what could go wrong?
One of the few dark clouds, in an otherwise relatively sunny global short-term outlook, is the deteriorating political landscape in Iran, which moves the whole region to the centre of the global risk map. There are, obviously, fears that the unrest will spread across the country and disturb the fragile geo-political equilibrium in the Middle East. It is also important to note that the regional economy had already shown some deterioration, although, according to the World Bank, Iranian GDP growth in the year (ending on March 20) reached 7.4%. The boost in growth was mainly driven by the oil sector following the removal of sanctions in January 2016. On the other hand, economic activity remains subdued in non-oil sectors, which recorded growth of only 0.9% year-on year in the first half of 2016 “as the delay in the Iranian banking sector’s integration with the global banking system continued to impede FDI and trade,” according to the World Bank. It is too early to assess all the implications of recent political trends in the region but one can conclude that the global political risk barometer has deteriorated at the start of 2018.
Another factor that could upset the sunny global outlook is the potential for an economic setback in China. China is currently targeting 6.5% GDP growth for this year and some commentators are starting to suggest that global investors might have become complacent with respect to China’s ability to deliver the required growth in order to support the expected global momentum. One can understand if economists are starting to wonder whether Chinese policy makers will be able to continue to generate an economic performance that meets the raised welfare expectations of its political constituents, whilst also addressing structural debt challenges. The IMF stated in October, for instance, that China's banking assets are projected to reach 310 % of GDP this year, which led to S&P’s downgrade of China’s debt rating in September. These downgrades are, however, less dramatic than they might seem at first sight: the Chinese central bank is likely to have adequate resources to counter potential short term contagion of debt fears and international market forces still play a limited role in determining domestic credit conditions. Overall, the most likely scenario for the Chinese economy can probably best be summed up as a gradual deceleration of the economic growth rate to a more sustainable long term pace. Even at a slower pace, China is likely to remain a formidable growth engine which, in the medium term, is unlikely to be derailed.
Other than the well-known threats to the world economy (the “known unknowns”), the year has started against a remarkably positive backdrop. The majority of the favourable economic trends have, of course, already been discounted by market participants, and not every additional positive headline can be expected to ignite positive market reactions. It is important to note, however, that statistical confirmation of gradually accelerating and widening economic progress is still most likely to remain a positive driver for equities.
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