We see stable global growth with room to run...
Setting the scene: the eurozone is enjoying its fastest economic expansion since 2011. EM (Emerging Markets) growth looks self-sustaining, even if powerhouse China slows more than markets currently expect. The breadth of the global recovery has expanded: Manufacturing figures are up in about 80% of countries, a share that has steadily increased over the past year. And U.S. tax cuts could provide a decent dose of fiscal stimulus. The caveat? Consensus expectations have mostly caught up with our GPS for G7 economies over the past year. See the "More growth, less upside" chart on page 3. This suggests less investor drive to play catch-up and embrace the positive growth outlook. Overall, we see very steady growth, coupled with still subdued inflation and low interest rates, as positive for risk assets — but with returns more muted. We expect global economic growth to chug along in 2018, but see less room for upside surprises to lift markets.
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We see a synchronized global expansion with room to run in 2018 and beyond, albeit with less scope for upside growth surprises. We see inflation making a modest comeback, led by the U.S., and expect the Federal Reserve to make slow but steady progress in normalizing policy. U.S. tax cuts could boost near-term growth and quicken the Fed’s pace. The eurozone and Japan are behind on policy normalization, but their next steps in this direction will likely come into greater focus as the year progresses. We expect rewards for taking risk to be more muted across the board in 2018.
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We believe low market volatility can persist amid the stable economic backdrop. Yet even a small uptick in volatility could upend leveraged income strategies and spook markets. We see few signs of leverage building in the financial system. The exception is China, where we believe much needed economic reforms risk slowing growth and triggering temporary credit crunches. We see the North American Free Trade Agreement (NAFTA) negotiations as a bellwether for global trade risks. We lay out a framework for assessing whether localized risks can morph into systemic ones.
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We prefer to take economic risk in equities over credit given tight spreads, low yields and a maturing cycle. We see rising profitability powering equity returns, especially in Japan and emerging markets (EMs), but earnings growth could wane. We like financials and tech. The steady expansion supports the momentum style factor, albeit with potential reversals; we see other factors as diversifiers. Plentiful global savings and a thirst for income should cap any rises in long-term bond yields. We prefer inflation-protected over nominal bonds, especially in the U.S., and an up-in-quality stance in credit.
