Hans Bevers and Bruno Colmant, respectively Chief Economist and Head of Macro Research at Degroof Petercam, provide their macro-economic views on 2018, while Jérôme van der Bruggen, Head of Investments Private Banking, explains how this vision will be translated into Degroof Petercam’s investment strategy.
Degroof Petercam expects 2018 to be a year of sustained economic recovery in the main geographic zones. The world economy continues its spiraling positive growth, although financial risks increase both on the stock exchanges and on the real estate markets.
Provided selectivity is applied, equities remain compelling. Our investment experts have an outspoken preference for European equity markets.
Degroof Petercam has lowered its bond portfolio’s sensitivity to interest rates and prefers shorter durations instead. Nevertheless, Degroof Petercam does not expect the normalization of monetary policy to result in sharply higher long-term bond yields. In a very low interest rate environment, Degroof Petercam proposes the following alternatives to government bonds: Investment Grade corporate bonds in euro, which offer a (limited) yield pick-up and durations which are often shorter than those of government bonds, as well as international inflation-linked bonds.
Global economy continues to grow for some time to come
Ten years after the onset of the financial crisis, the global economy is showing signs of a synchronized recovery. Cyclical economic growth across the board is picking up, trade volumes are growing, corporate profits are on the rise and unemployment is falling. The combination of extremely loose monetary policy, low commodity prices and neutral fiscal policy is coming to fruition. So far, however, this has not trickled down into clearly rising wage and inflation readings. The major challenge in the years to come will be to remove monetary life support without hampering economic growth and upsetting market psychology. This approach would mean that central banks once again have monetary leeway in the future. In that regard, however, there is no clear trajectory. Nevertheless, monetary policy makers will need to communicate clearly and in a timely manner, move gradually, consider all options and keep central banks’ balance sheets at high levels in the future. In addition, future equilibrium interest rates will be a lot lower than in the past. Nonetheless, this chimes with an increase in financial risks, on financial markets as well as on property markets.
US: Fed will continue to hike interest rates
The United States are currently seeing the third-longest economic expansion in history, with the yield curve gradually flattening. However, we believe the odds of a new recession are fairly low. President Trump’s tax reform will give economic growth a small boost, but will result in deteriorating public finances and growing inequality. However, we do expect inflation to rear its head again. Gradual tapering of monetary policy is in the cards, and as things currently stand it is plausible that the Fed will hike interest rates another three times by the end of 2018, to 1.75-2%. This may result in a slight appreciation of the USD, but a significant boost should not be expected, given current valuation. Moreover, Janet Yellen’s term is drawing to an end. Jerome Powell’s vision closely resembles that of his predecessor’s, but four out of seven Fed seats must be filled again, and this may cause some additional uncertainty.
Eurozone: cyclical recovery on track
In the past two years, the European economic cycle has caught up significantly, and is doing very well today from a cyclical point of view. All sectors are recovering, and the labor market is thriving again. However, there is no full-fledged recovery yet. Unemployment remains above pre-crisis levels, and there are major divergences between countries. Moreover, there are many discouraged workers who have dropped out of the labor force in the past few years, as well as part-time workers who would rather work full time. Hence, it does not come as a surprise that wage pressures will remain modest for some time to come, and that inflation will remain below the 2% target. As such, tighter monetary policy should not be expected any time soon. Here, the ECB will want to avoid the mistake it made in the past, namely to tighten monetary policy too soon. In addition, a further euro appreciation would be detrimental to reaching inflation targets. It is too soon for an actual rate hike, and this will only come after the ECB has put an end to its asset purchase program, presumably in September 2018. The first rate hike will probably come in the spring of 2019, at the earliest. Meanwhile, tough Brexit negotiations and the potential political deadlock that may arise after the Italian elections are the main short-term risks.
Emerging markets: cooling Chinese growth with limited impact on world economy
There is a slew of elections coming up: in South Africa, the ANC must start looking for a new leader, in March and May respectively Russia and Colombia will be holding presidential elections, and Indonesia has planned local elections in June. Furthermore, there will be general parliamentary elections in Mexico (July), Malaysia (August), Brazil (October) and Thailand (November). The elections in Mexico and Brazil may in particular cause some upheaval. In the past year and half, China’s economy has settled down. However, credit volumes have ballooned in an unsustainable way. Against that backdrop, China’s central bank tightened monetary policy less than one year ago. As a result it will be increasingly difficult to take structural measures to make the Chinese economy more sustainable and maintain the high 6.5% growth target at the same time. Hence, we expect growth in 2018 to decelerate. China continues to be one of the major risks to the global economy. A slowing Chinese economy will have some fallout in the rest of the world, resulting in lower trade volumes and commodity prices. However, concerns about a severely negative impact on the rest of the world remain subdued for the time being. The rule of thumb is that a 1% decrease in Chinese growth results in a 0.25% drop in global economic growth.
What assets to invest in for 2018
Equities: clear preference for Europe
Equities are fairly valued to expensive, in function of the region. US equities in particular are expensive historically speaking and according to various valuation metrics. Provided selectivity is applied, there are compelling securities to be found in the US. However, Degroof Petercam mostly sees opportunities in Europe.
“Given a forward PE of 15x (about historical average), a dividend yield which is worthwhile when compared to bond yields, and expected earnings growth which may still surprise on the upside, European equities remain attractive. Also in the coming year, market liquidity will remain abundant,” argues Jérôme van der Bruggen, Head of Investment strategy Private Banking at Degroof Petercam.
Bonds: short durations and investment grade
Degroof Petercam has lowered its bond portfolio’s sensitivity to interest rates, and prefers shorter durations instead. Nevertheless, Degroof Petercam does not expect the normalization of monetary policy to result in sharply higher long-term bond yields. In a very low interest rate environment, Degroof Petercam proposes the following solutions: Investment Grade corporate bonds in euro, which offer a (limited) yield pick-up and durations which are often shorter than those of government bonds, as well as international inflation-linked bonds, especially in the US.
“While inflation has disappointed recently, inflation-linked bonds are compelling. Inflation has been influenced by transitory elements. Overall growth prospects and the improved situation on the labor market should result in a modest inflation pick-up. We believe that the valuation of inflation-linked bonds does not fully reflect this perspective,” says Jérôme van der Bruggen.
Currencies & gold: Diversification
Based on purchasing power parity, and in spite of its recent depreciation, the dollar remains overvalued versus the euro in a long-term perspective. Nevertheless, Degroof Petercam is presuming that the US dollar will consolidate in 2018 due to the diverging monetary policy in both regions.
Despite being quite volatile, gold retains a solid position in any well-diversified investment portfolio. Real interest rates are extremely low, which results in a very low opportunity cost for gold, supporting prices. Like the US dollar, this asset class can be a safe haven in times of extreme turmoil or surging inflation.