Strong start to 2018 for equities
This year has started very strongly, as S&P 500 has risen 3.5% YTD. It is now 389 days since we had a 5% drawdown, which is close to the record from the 1990s of 393 days. One reason is that economic data remain very strong, not least in the euro area. Economic confidence in the euro area has been higher only in 2000 during the IT bubble, industrial production rose 1% in November and the unemployment rate has fallen to 8.7% (the lowest since the crisis). The combination of high consumer and business confidence in both the US and Europe means growth is likely to be more balanced between private consumption and business investments than in the past two to three years. While we think the acceleration phase is over, we expect global growth to stabilise at a strong level, supporting our view that equity markets should do well in 2018 too. In our view, the main downside risk is China due to a combination of credit tightening, renewed reform push and anti-pollution measures.
Despite the strong economic cycle, the missing link is still inflation, which we expect – as in recent years – to remain an important topic this year. Based on meeting minutes from both the ECB and Federal Reserve, the persistent low inflation is the biggest puzzle for central banks right now. Normal economic wisdom says inflation should move higher as the output gap closes but inflation remains low globally. Last week new data showed that euro area HICP inflation was lower than expected in December and wage growth remains modest in the US. With Brent oil trading just below USD70/bl, the reflation theme is slowly returning to markets and inflation expectations have risen in both Europe and the US. One reason for the higher inflation expectations is that central banks have been determined to stay on course and not turned too hawkish despite their inner eagerness to tighten monetary policy at this point in the cycle. While the higher oil price puts upward pressure on overall inflation in the short term, we believe core inflation is likely to remain subdued in both the US and Europe, as wage growth remains modest and inflation expectations, despite increases, remain below average.
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