Curmi & Partners

2018 - the year of the dog.

Article by David Curmi

Is it? In many ways, certainly from an economic sense 2018 should be a good year. Coming off the back of a year when we witnessed an acceleration in economic growth in Europe we enter the new year with optimism that this growth will carry on.  My focus here is not so much Malta where we are indeed witnessing quite remarkable growth, but more so mainland Europe. 

The economic landscape improved markedly in Europe throughout 2017.  Whilst early numbers suggested growth of approximately 1.7%, this figure expanded with median economic forecasts now expecting the year to close off with 2.3% growth.  Expectations for 2018 are also good with the “stronger for longer” theme resonating well across market players.  Meanwhile in the US we are now in the latter stages of a pretty longish growth cycle. Peak cycle is also expected to take place in 2018 with growth topping out there at around the 2.5% before perhaps easing off.

It is quite remarkable however that it has taken some 10 years since the financial crisis, a Herculean effort on the part of central banks through their respective QE programs and interest rates at or around the zero level for some years to squeeze out this growth.  It is no surprise that we greet these numbers like we would a returning long lost friend. 

And yet, whilst we should indeed rejoice in these numbers there is perhaps a trojan horse or two that we may need to be aware of.  Despite the pick up in growth, inflation remains stubbornly low.  Central bankers on both sides of the Atlantic have grappled with this phenomenon without really being able to explain it forcefully.  With unemployment levels reducing substantially inflationary pressures are expected to begin building, but only modestly. 

As economic numbers remain moderately strong and inflation slowly builds policy makers are expected to remain in tightening mode in the US with interest rates expected to be raised three times in 2018, each time rising 0.25%.  In Europe, the ECB remains in a holding pattern on interest rates.  No move expected in 2018, but a tapering of the QE program, or perhaps even its full termination is scheduled for September next year.  All in all the economic backdrop remains a positive one.

The real challenge comes when overlaying this backdrop onto where equity and fixed income markets are presently.  2017 has generally been a strong year for equities, other than perhaps the Malta Stock Exchange.  This begs the question however, as we enter 2018, as to how much further can valuations expand.  Over recent weeks many banks and commentators have called the end to the bull market in equities.  By most counts the bull market in equities is long in the tooth and we are now climbing a wall of worry.  We are still caught between not wanting to be left out and not wanting to be the last one to leave, what by all accounts is an enjoyable party.  Witness the volatility in the market.  This is starting to creep up.  A sign that uncertainty is growing.    On the other hand, with yields so low and with interest rates expected to remain low in Europe, do you want to go into the bond market if you exit equities?  Good question.  The bond market has been an even stronger performer and whilst there are still pockets of value, we are very much at the tail end of this cycle.  Though interest rates are not expected to rise in the near term, a fixed income strategy needs to be cognisant of the risks that present valuations bring, especially against a back drop where the market begins pricing in some upward movement in rates as we drift through 2018.

This remains the big dilemma.  Both asset classes have performed well this year and having moved in tandem, the risk that a correction in both asset classes occurs has increased.  The need therefore to be nimble and perhaps run tougher slide rules over which equities to remain exposed to is going to be critical.  Timing entry and exit points may also help but this is often a mugs game. 

What is fairly clear is that 2018 will be a difficult year, one with higher volatility and lower returns.  The year of the dog perhaps! At least the Chinese horoscope predicts that 2018 will bring happiness.  Let’s hope so.

The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.