Generally, the month of May was consistent with the 2018 story of a global economy entering a mature stage characterised by market volatility, the gradual emergence of inflation, higher interest rates (primarily in the US) and a softening of global economic growth indicators.
Since February, equity market volatility has jumped from historically low levels, although this largely seems to have been technically-driven. Continued synchronized global growth and historically low interest rates are still supportive of equity markets, while economic indicators are not yet signaling the end of the business and market cycle that started in 2009.
Potential trade wars and interest rates have dominated the news in March. The first quarter of 2018 continues to show signs of more volatility and nervousness in markets particularly as the US, being furthest of the advanced economies through its cyclical growth, presents a different economic narrative to the rest of the world.
Aside from the February turbulence in equity markets, global economic growth should hold up well and inflation should remain low in 2018.
The recent hard economic data and survey evidence suggest that the world economy is growing at a rate over 3% pa and there is enough spare capacity in many economies for the expansion to continue for a while yet.
Global GDP growth of 3.3% (last year 3.2%) is expected in 2018 broadly to support share markets, but it may still be a pivotal year for the markets as many of the larger central banks around the globe are moving in unison on a path towards monetary normalization, and therefore higher interest rates.
Although the economic outlook is positive for 2018, we are fully aware that sharemarkets have risen sharply in recent years and valuations are high. Consequently, we will continue to monitor economic and political developments for any negative signals.
Sharemarkets remain firm: the preconditions for strength remain, i.e. global economic growth is strong and synchronised, inflation is modest, recession risks remain low and company earnings are expanding at a double-digit rate.
Even though the current bull market in shares is now over eight years old, we believe that the risk of an imminent global bear market is not high. There are two main reasons for this. First, inflation has played an important part in rising bear market risks in past cycles. Structural factors may be keeping inflation lower than in the past and central bank forward guidance is reducing interest rate volatility. Without monetary policy tightening, concerns about a looming recession – and therefore risks of a ‘cyclical’ bear market – are lower. Second, financial imbalances and leverage in the banking system have been reduced post the financial crisis. This makes a ‘structural’ bear market less likely than in the past.
Earnings momentum is now positive for all major equity regions and we expect this to continue, supported by a solid economic backdrop. A normalising global economy should allow central banks to unwind their ultra-accommodative interest rate policies. We believe that long bond yields are set to rise further during 2017 and 2018.
Improving economic growth around the world will generally support equities and challenge bonds. That’s because this growth is more ‘traditional’ in nature, arising from better employment and demand, and thus allowing prices (and potentially profits) to rise.