Deutsche AM: Constructive, but vigilant approach to the new year
We are expecting year nine of the economic upswing. The rally is not over yet. Although this cycle is very far advanced, there is scope for the equity markets and the global economy to continue to perform well.
This year only three per cent of the world’s countries were in recession, one of the lowest levels in recent years. Industrialised and emerging markets have surprised markets with good economic figures. And for the first time in ten years, 2017 will mark two-figure growth in corporate profits simultaneously in the US, Europe, emerging markets, Japan and China.
We do not expect headwind to come from higher inflation or central banks setting more restrictive interest rate policy. In the foreseeable future, three of the five major central banks are likely to increase rates, but this will be at a moderate level.
Any stimulus from bond buy-backs will also continue into 2018 in Europe and Japan. Nevertheless, the beginning of the end for ultra loose monetary policy has arrived. It will be interesting to observe who positions themselves to take over the top job at the ECB in 2019 and does not expect the new Fed chief Jerome Powell to make any fundamental changes in US monetary policy.
“Keep it up” on bond markets
It is not yet time to write off the US dollar as maximum divergence has been reached. This is partly due to the fact that economic growth in the Eurozone has been a positive surprise. In addition, the EU has gained in popularity with its citizens and the political scene is generally more stable than in the US.
In terms of bonds, we see little need to amend last year’s forecast. The greatest opportunities lie in corporate bonds, with US dollar bonds producing better returns than euro bonds, even after hedging costs have been deducted. High-yield bonds are particularly interesting. Those from emerging markets offer similarly high returns as they are supported by a strong fundamental environment, good growth and low inflation. This coming year, active duration and currency management will also be important
Profit expectations drive the equity market
A good economic performance should be reflected in the equity markets, having said that equities are currently expensive. The upswing will continue in the coming year and it will be carried by expectations of good corporate profits: Equity prices follow corporate profits.
The key stimuli in 2018 are expected to come from the technology sector as well as emerging markets, Japan and Europe. In addition to high demand for technology, the financial sector could turn out to be the second strong sector in 2018. In the US, there is the prospect of reduced regulation, an interest rate hike and higher dividends. In Europe, consolidation continues at a pace and restructuring efforts will bear fruit. Although confident, we do not expect stock exchanges to deliver returns with such low volatility as they did in 2017. An end to this course could be brought about by unexpected inflation figures, disappointing growth figures out of China or the collapse of plans for tax reforms in the US. Investors currently have a high appetite for risk. As such, there could be abrupt liquidations of risk positions in 2018.
Markets are in the late phase of the cycle. Diversification of investments is now particularly important. Deutsche Asset Management’s model portfolio in the multi-asset arena currently comprises 40 per cent bonds, 45 per cent equities and 15 per cent alternative investments. As potential components of alternative investments, Infrastructure investments as well as gold will be well positioned for the new year.
Stefan Kreuzkamp, Chief Investment Officer at Deutsche Asset Management