The mature global equity bull market could celebrate one last blast of exuberance in 2018 before finally succumbing to old age late in the year, Russell Investments says in its latest annual outlook.
According to the Russell ‘2018 Global Market Outlook’, stretched valuations, central bank tightening, and “long in the tooth” fundamentals suggest a correction may be well overdue.
“But markets may surge as investors, buoyed by their recent success, become overconfident and start believing (again) that this time is different,” Russell says. “… Our central view is that equity markets can push higher over the first part of the year, before facing headwinds later in 2018 as markets factor in rising risks of a 2019 recession.
“Running with the bulls can be dangerous. It’s easy to get swept up in the elation of the crowd and underestimate the risks.”
While equity markets have yet to hit the full ‘euphoria’ phase – usually the precursor to a crash – the Russell report says impending US interest rate rises could equally kill the party mood in 2018. Russell has factored in three Federal Reserve hikes next year, moving base rates up by 1 per cent, which could create the conditions for a US recession.
“Credit and equity markets tend to price in recessions around 6-12 months ahead of time,” the outlook says. “This means that 2018 could be a year of two halves. The first, which sees the continuation of the current market momentum, and a second half where markets begin to focus on the downside risks to U.S. and global growth.”
Overall, Russell remains more upbeat about prospects for Europe in 2018 – barring Brexit side-effects, Italian financial sector risks, and a China meltdown – tipping “strong fundamentals and relatively attractive valuations” could sustain the rally in Euro assets next year.
The Asia-Pacific region, too, appears poised to rock on through 2018 “underpinned by robust growth in China and the global economy”, the report says.
“Valuations are looking a bit expensive, but within the region there remain pockets of fair value,” Russell says. “Late-cycle dynamics in the global economy will further boost regional growth.”
New Zealand, though, will likely experience a slow-down in growth as a Labour government-induced decelerating housing market and declining migration takes its toll next year.
“Despite this fall in house prices inhibiting consumer confidence and household consumption, we think the RBNZ [Reserve Bank of NZ] will view any slowdown or mild turndown in prices favourably, as they had expressed significant concern about financial excesses,” the outlook says, indicating a “base case” of one rate rise in 2018.
Consequently, the NZ equity market could be hit by reduced consumer spending, Russell says, although the damage may be limited by solid corporate earnings “underpinned by global demand”.
The NZ dollar – joint worst-performer (along with the US) in 2017 among the 10 most-traded global currencies – looks set for further weakness next year, especially if economic conditions deteriorate.
“The antipodean currencies, (AUD and NZD), are at risk of underperforming as their rate buffer is slim relative to history,” the Russell outlook says. “As commodity-linked currencies, they are also more vulnerable to any potential growth slowdown or downward correction in risk assets.”
Elsewhere, Russell also earmarks gold and carbon for attention next year as the respective forces of rising inflation and sea levels impinge on investors.
“Late cycle dynamics favour hard assets (e.g. gold) over shares and bonds. That’s because, late in the cycle, strong volume growth with low inflation is succeeded, post-intermission, by slower volume growth but resurgent inflation,” the paper says. We’ll particularly be watching the gold price for signs of rising inflation and/or any loss of faith in fiat currencies.”
Concern about climate change, meanwhile, is prompting a huge interest in low-carbon investments, Russell says.
“We have seen a seismic change in the responsible investing arena as investors and shareholders look to encourage companies to reduce their carbon footprint and regularly report.”
Russell says markets will probably remain in a low-return environment “in coming years” requiring investors to diversify, implement portfolios efficiently, and be ready to tack according to conditions.
“In other words, [investors] need to squeeze every basis point out of their portfolio using smart strategies, implemented in a cost-effective manner, backed by a dynamic process that leans into opportunities and away from risks,” the outlook says.