Industry Voice: Could these be the market's 5 key themes in 2018

With 2018 now in full swing, market growth momentum seems strong and synchronised - yet everything is feeling a bit "toppish", especially with central banks heading for the QE exit doors.

 

On the valuation front, most metrics are higher than during the dot-com boom and sub-prime crisis. We're not calling a crash - not yet, anyway - but with liquidity infusions set to grind to a halt there's no room for complacency. While we expect a positive start to the year, regional and asset class returns could diverge during 2018.

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Let's take a look at the five main themes we expect to move the markets during the year.

1. A fiscal push

One of the main themes will be US tax reform and a rise in capex. In the US, tax reform means equities should perform well early in 2018. Winners could include domestically oriented names, small caps, retail, the tech giants, and possibly banks. However, highly indebted companies will struggle with the limits imposed on interest deductions so we're wary of US high-yield bonds.

In Europe, we expect more of a cyclical pick-up in investment, while the Japanese government is rumoured to be ready to incentivise companies to invest their cash.  In China, reforms focusing on the environment, electric vehicles and profitability should also fuel capex.

All this could bode well for commodities (excluding agriculture) and infrastructure as well as sectors like materials, technology and financials.

2. The withdrawal of QE

Central banks look set to move further away from their super-accommodative policies. So far, policy normalisation has proceeded with little upset, and risk-on strategies remain appealing for now. But it could be time to consider preparing your portfolio to dampen the effects of rising inflation and rates, market volatility and currency movements.

Ten-year US Treasuries - a safe haven that is still in great demand - and German Bunds look good options in a risk-off scenario.  Japan also appeals because of its loose monetary policy, while minimum variance strategies could be an option for equity investors.

While the major central banks currently look set to tighten, any slowdown in global growth would halt monetary policy normalisation immediately. It's taken a decade to heal the global economy, and they're not about to jeopardise their hard work by tightening unduly.

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3. Bond yields to rise... eventually

The good days for bonds could be over. Some factors keeping rates low remain in place, but the global economy is in its best shape in a decade and the threat of deflation has disappeared. Our core scenario is that yields rise - although we're not calling a market implosion.

In such an environment, we recommend reducing duration. Countries where inflation (or growth) is less likely to be better than expected, such as Japan and the UK, look the best option in the government bond universe.

We also like inflation breakeven stories, starting with the US early in the year and the eurozone later in 2018.

Floating-rate contracts are another possibility to help deal with the threat of rising rates, as are short-duration bonds. Credit - notably high yield - looks expensive. We prefer European to American bonds as the ECB will remain active in the markets at least until September.

4. Asia advances

Asia ex-Japan outperformed last year and the three major indicators we follow - earnings, valuations and liquidity - are still sending positive signals.

What's more, an improving structural story keeps us positive on Japan - especially given the likelihood of another four years of Abe's loose policy mix.

In China, there's value to be found in the reform of state-owned enterprises and the focus on the environment. Shorter-term, Chinese equities look unlikely to repeat their stellar 2017: monetary tightening is underway and excesses are being tempered.

In emerging Asia we favour Korea on valuation grounds, surging earnings growth and improving governance. We also like ASEAN markets, especially Malaysia.

How to prepare for 2018: Seize opportunity. Avoid complacency

5. Be selective in Europe

With European equity valuations well above their long-term averages, a selective approach will be key in 2018.

We like French stocks given the general recovery and the progress of "Macronomic" reforms.  German stocks also look attractive, especially if a Grand Coalition leads to increased government spending.

Conversely, the ECB's gradual withdrawal of QE and a number of political hurdles cloud the outlook for Italy and Spain. And Greece could also hit the headlines this year. With its third bailout package ending in August, it will need to re-access the bond markets.

Meanwhile, UK equities continue to face Brexit battles. The agreed-upon divorce deal should bring some hope, but trade treaty deliberations complicate the outlook.

Find out more about Lyxor's investment outlook at LyxorETF.co.uk

 

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