Monthly Market Outlook December 2017/January 2018Monthly Market Outlook Article
Over the past year, global equity markets have marched upwards, buoyed by a cyclical growth upswing the world over. This bull market has been seemingly unfazed by Brexit, a politically inexperienced White House and escalating tensions on the Korean peninsula. We have regularly commented throughout the year that one must look through short-term volatility and political noise. We expect that this may very well be the case again over the course of 2018.
The US economy is looking particularly robust, with soft economic data coming in at multi-year highs. This solid backdrop, supported by strong corporate earnings growth, has led the US equity market to all-time highs in recent weeks. At the end of 2017, Trump made his first major breakthrough in terms of policy, with his long-awaited tax reforms finally passing through Congress. This is expected to be broadly positive for US equities despite a likely initial hit to balance sheets from a reduction in deferred tax assets. Early estimates are pointing to a 10% addition to corporate earnings as a result of the reforms, which could mean another strong year for the S&P 500.
December saw Janet Yellen's final press conference as Chair of the Federal Reserve ("the Fed"). Given the broad based strength in the economy, the Fed had confidence to hike rates for the third time this year. This came as no surprise to markets. More recently, US labour data modestly disappointed but unemployment remains very low at 4.1% and wage growth appears to be firming. Inflation expectations have picked up over the past few weeks, which should provide further comfort for the Fed to hike 3 times this year as indicated by their forecasts.
In the UK, there remains a lot of political uncertainty. Going into Brexit negotiations, the UK would have hoped for domestic politics to have been far more stable than they currently are. The recent government reshuffle has proved to be more divisive than progressive, with senior members of the cabinet resigning. Since the progress last month in completing phase one of the Brexit negotiations, there has been a lot of noise about the future path of discussions. Until there is more clarity on how the divorce will proceed, we would still encourage investors to look through the noise. Momentum in the UK economy remains fairly robust, with soft data still at solid levels however, consumer sentiment hit its lowest level in four years in recent weeks. Inflation sits significantly above the 2% target level at 3.1% but should be near its peak as base effects start to come out of the equation. Our expectation is that rates will stay on hold until there is more clarity on the breakup or a marked pickup in economic activity.
European equity markets had an impressive 2017 but have been somewhat stagnant over the past month. The European Central Bank ("ECB") started this year with its reduced asset purchasing programme of EUR30bn per month compared to EUR60bn per month prior. There has also been some hawkish commentary of late, which hints that there will be no further extension of the programme when it finishes at the end of September this year. At the start of 2017, European political concerns abounded and the beginning of this year appears to be a similar story. Merkel is struggling to form a coalition in Germany and an Italian election is scheduled for March, where the populist anti-EU Five Star Movement are leading in most opinion polls. On the other hand, tensions in the Spanish region of Catalonia appear to have subsided for now.
The Bank of Japan surprised markets at their latest meeting by trimming purchases of bonds in excess of 10-year maturities. This change gave less support for long-dated debt and had a knock-on effect to other global bond markets. The Japanese economy is growing moderately and hopes are that inflation begins to tick up after years of weakness.