As we enter the fourth quarter, thoughts are inevitably turning to the outlook for 2018. But the only question we really need to think about is what, if anything, supports the bull story for 2018.
Few catalysts for higher growth spring to mind for next year, with the global economy having seemingly used up its stimulatory tailwinds in 2018. The boosts from China’s 2016 stimulus, low oil prices and loose financial conditions are all likely to fade next year.
Indeed, today’s tailwinds could well become tomorrow’s headwinds. Having tightened his grip on power, Xi Jinping seemingly wants to prioritise China’s quality of growth rather than its quantity. Growth won’t be allowed to drift down too far, but the global economy appears unable to count on China for the next few years.
That said, the global economy is still in rude health, with our leading indicator showing an improvement in growth momentum over the past few months. There are bright spots in the global economy, with the eurozone likely to continue enjoying above trend growth as pent-up demand from the previous decade continues to come through. A higher oil price could make a material difference for the US in 2018, with figures from UBS estimating that the energy sector has contributed 140 basis points to US growth this year.
Tax reform could also make a material difference to US equities, though the nature, timing and magnitude of any package is uncertain. Some estimates suggest that tax reform could add $10 to earnings per share, not to be maligned if growth disappoints and earnings are otherwise flat. But of course, ‘Trump disappointment’ is an entirely plausible scenario too.
While tax reform might be welcome, it highlights the difficulties politics raises for investors in 2018. Several important markets now have structural reform arguments to them. The US, French and Indian governments are all promoting structural reform to some extent, whether that’s on tax, labour markets, or a broader transformation altogether.
Structural reform, and its chance of success, are a much more nebulous concept to address than the outlook for earnings or the macro environment. Sentiment around reform often fluctuates wildly, or can remain disconnected from fundamentals for prolonged periods of time. Investors have been far too optimistic on Brazil, for example, where the fiscal outlook continues to deteriorate and growth remains sluggish, even after a sharp recession.
For the start of the year, markets may just stay in a holding pattern, waiting to see how reforms play out, and how other changes develop, including the withdrawal of quantitative easing. It will be important to closely monitor the data in the meantime, searching for anything which might upset investor sentiment, and the extraordinary period of low volatility we have seen recently. While I think we’re definitely in the late stages of the bull market, investors may want to stay overweight equities, at least for the start of the year. With low return prospects elsewhere in markets, being braver for longer should be a cornerstone of investors’ strategy.
James Bateman is CIO, Multi Asset, Fidelity International