Next year is likely to see a continuation of the steady worldwide economic recovery that has equities poised to rise for a fifth year in six. Equity valuations are getting high but the bull market is probably going to run for at least another year or two.
Global equities, as measured by the FTSE All-World index, have climbed almost 20 per cent so far this year; a year which has seen the strongest period of global GDP growth since the financial crisis.
We have a robust global expansion with low inflation. It takes time to slow an economy down, even if you want to, and central banks are not in a hurry to cool things off. They will be quite gradual.
That said, interest rates are going up over the next five years or so. The Bank of England raised its policy rate in November from the lowest level on record, while the US Federal Reserve increased rates twice this year and markets are pricing in a third hike in December. The European Central Bank left rates unchanged, but announced two reductions in the pace of its monthly bond purchases.
While the UK economy is expanding, growth has been sluggish compared with strengthening activity in Europe and further afield, with Brexit uncertainty weighing on consumer confidence and business investment. I would not be surprised if the Bank of England is “one and done” as far as rate hikes. The Brexit negotiations are going to remain messy and inflation should drop sharply in the New Year as year-on-year base effects change. I just do not see it pressing ahead with further tightening.
Looking ahead to 2018, GDP growth should be supported by a modest improvement in household consumption as real income growth recovers. In Q3 2017, GDP growth picked up slightly to 0.4 per cent quarter-on-quarter.
In my estimation, there is a 10 to 20 per cent chance we will remain in the European Union or the single market, and an equal likelihood of leaving the EU without any trade agreement whatsoever. Investors and business leaders are facing unprecedented uncertainty as to the level of the pound.
If the public mood shifts and we stay in the single market, the pound could recover its post-referendum losses of 10 to 15 per cent. If we leave with no deal, it would be like the Brexit vote happening all over again, with maybe 10 to 15 per cent of downside. All this depends on negotiations between politicians behind closed doors.
Our “investment clock” is in the equity-friendly Recovery phase, with strong global growth and low inflation. But if inflation starts to rise, it could move into the Overheat phase, when commodities historically have tended to do better and conditions for bonds are more challenging.
The price of crude oil exceeded $64 a barrel this year and copper traded above $3 a pound for the first time since 2014. Some investors view higher commodity prices as a harbinger of inflation, and China is the largest consumer of commodities.
China is reining in economic growth again, and a slowdown will be visible over 2018. The economy expanded by 6.8 per cent year-on-year in Q3 and stronger global growth has supported industrial production. China is the most important economy in the world in terms of inflation.
Weakness could cause volatility in stockmarkets but, perhaps a bit counterintuitively, a managed slowdown in China – which is what we have seen for the last five or six years – is bullish for global equities. That is because it means commodity prices cannot really get a head of steam, and inflation and interest rates stay low.
Tech stocks to shine
I am cautious about bonds, given my outlook for higher interest rates. But US tech stocks – the Facebooks and Amazons of the world – may have the potential to achieve further gains, even after doing extremely well already. Amazon shares trade for more than $1,100 apiece, and Apple has a market capitalisation of almost $900bn.
If economic growth stays strong and interest rates stay low, there is the potential for technology shares to see a 1990s-style blow-off on the upside. The more they go up, the more the risk of a setback rises, but I do not think we are at that stage yet.
Trevor Greetham is head of multi-asset at Royal London Asset Management