Outlook for 2018

Jonathan Eng

This week’s article will focus on some market expectations and key themes to look out for in 2018. Bank of America Merrill Lynch Global Research predict a macro bullish year so much so that they are ultimately bearish as investors seek to rein in after a prolonged period of growth. Global economic growth looks robust at a predicted average growth of 3.8%, with the US equity markets set to strengthen into H1 2018 and US tax reform looking to pass. Expect tighter credit spreads as the USA and European Union look to taper off QE, signalling rising inflation and problems for secondary bond markets.

2017 has been underlined by steady economic growth, with little signs of any obvious bubbles forming in markets and the VIX volatility index staying consistently low. This has resulted in investors seeking higher-yielding equity returns with 2018 set to be ‘a year of euphoria’—as stated by Merrill Lynch market strategists.

These are some of the main themes to observe in 2018. Markets are still largely bullish but this may result in investors pulling back to prevent backlash and as such expect potential dips in H2 2018. But overall it is set to be a pretty good year.

S&P Index growth

The S&P is expected to reach 2800 by YE 2018, with earnings expected to grow by 6%. Trump’s highly anticipated tax reforms are looking to contribute almost 14% to S&P Earnings Per Share.

Global Economic Growth

US GDP growth is expected to be 2.4%, up from 2.2% in 2017. Eurozone growth is expected to be around 2%, with Japan and China expected to grow 1.5% and 6.6% respectively. Emerging markets are also estimated to grow on aggregate by 5%.

Higher Rates

With the Fed set to raise their rate once more in December, it is likely that there will be further rate hikes in 2018 should tax reforms pass and markets perform in 2018. Monetary tightening in the UK will largely be influenced by Brexit negotiations and reductions in inflationary pressure.

The Return of Inflation

With interest rates being near-historic lows for as long as they have, a rise in rates signals a return of central banks attempting to maintain their inflation targets. Whilst the Federal Reserve suggests that their inflation target will not be achieved in the short- to medium-term, an end of year rise indicates that the US economy is back on track with solid domestic figures and steady economic growth.

Debt Market  

Supply of bonds are likely to decline with the cost of issuing rising with rates and support from central banks falling away as money supply from QE continues to taper off. New issuance of US high-grade bonds could decline up to 17% while European supply falls 6%. Asia is set to remain constant with rates in Asia staying flat as well. If rates continue rising, existing bonds on the secondary market will start trading at a discount as the nominal value of the bond decreases due to depressed demand, lowering bond yields for the flush of bonds that have been issued in the market over the past years.

China

By increasing allowed-foreign ownership in a foreign company from 49% to 51%, effectively allowing foreign investors to retain control of their investments in China, and easing tariffs on certain luxury goods imports. China is slowly but surely opening its market more and more to the global economy. The extent of this might still be limited in the short-term while the RMB remains pegged to the USD. Furthermore, with promise of greater global economic integration from the 19th National Congress as well as a promise to deleverage, China is also looking to start focusing more on domestic-driven demand to drive the economy and rely less on export-driven growth. Perhaps a signal to takes its place on the global platform as a hegemon, or perhaps just another move to prop up economic growth and validate the CPC. Only time will tell what China’s true intentions are.

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