2017: A risk-on record breaking year
It was a record-breaking year for stocks, with some U.S. stock markets making breaking records a daily occurrence. The UK market joined in the record breaking year, however Brexit uncertainties held investors back. The weaker pound, often seen as FTSE-friendly, was not enough to bring the UK stock markets in line with global peers.
It was undoubtedly the year of the cryptocurrency. Bitcoin started the year around $1,000 to reach record highs of $19,666 In December. Bitcoin futures are now trading on global platforms CME and CBOE, while a variety of altcoins - alternative cryptocurrencies - have also seen their value rocket.
Traditional safe haven gold was dented by the crypto-frenzy. Gold saw a small uptick on the first intercontinental ballistic missile test from North Korea, however the subsequent tests, which saw missiles launch over Japan, failed to push gold higher.
It was a fairly gloomy year for UK markets as the country adjusted to the the result of the June 2016 referendum, when the country voted to leave the European Union. Confidence in the market was shaken by uncertainty surrounding the UK’s future position outside the European Union.
The snap election in June 2017, just before negotiations to leave the EU began, further clouded the UK outlook. Prime Minister Theresa May lost her majority in government, and left her mandate at the will of her Brexiteer backbenchers and the Northern Irish Democratic Unionist Party, now kingmakers. Party infighting and bat and ball between the chief Brexit negotiators on opposite sides of the Channel have done little to help the beleaguered pound. Following the referendum, the pound plummeted, while higher inflation and stagnant wage growth led to the downward revision of growth forecasts for the coming years.
The pound spent much of 2017 at the mercy of the political hopscotch surrounding the negotiations. While GBP has lifted itself away from post-referendum lows of near 1.20 against the dollar, some of this can be attributed to dollar weakness. Looking closer to home, the Brexit impact can be seen on sterling's performance against the euro.
Growth in the euro-zone has seen the single currency spend much of 2017 hovering just below 0.900 against the pound. While the euro-zone has had its fair share of political drama - calls for independence in the Spanish region of Catalonia and the fact Germany hasn’t had a government since September - booming growth throughout the currency bloc has triumphed to push the EUR higher.
2018 will be the make or break year for the Brexit deal. December 2017 saw a lightening of the Brexit mood amidst more positive rhetoric from both camps, so the year ahead may continue in this vein.
As we enter phase 2 of the Brexit negotiations, when details of the all-important trade relationship will be discussed, we asked a number of our most popular contributors to tell us how they believe markets will perform into 2018.
Michael Hewson - Sterling risks to the downside
Forex
2016 turned out to be a bit of a shocker for the pound which had its worst year since 2008, falling 16% against the US dollar and 11.5% against the euro, as a result of the outcome of the Brexit referendum vote. The currency had also been coming under pressure as a result of expectations that the US Federal Reserve was building up to raise rates further, a fact that swiftly came to pass at the end of last year.
Predictions of parity against the euro and US dollar proved wide of the mark and despite the triggering of Article 50, the loss of a Conservative majority in the June election the pound has held up well. The resilience of the pound has been helped by the Bank of England’s decision to reverse last year’s rate cut, though it has lost ground against the euro, as economic conditions have improved throughout Europe prompting speculation that the European Central Bank will step back from its currently easy monetary policy.
Looking ahead to 2018 the currency situation remains much less clear since the lows of $1.2000 earlier this year, however it is important to remember that sentiment remains quite pessimistic raising the prospect of a move back towards $1.4000, if a doomsday scenario doesn’t play out.
The technical break of 1.3600 last year, the previous 35 year low was, and remains a negative development, and thus far the rebound we’ve seen this year has been capped here, with solid support at the 1.1950 lows.
While the political situation in Europe has improved having navigated the various elections we still have the small matter of Italian elections early next year. We also don’t appear to have a functioning German government which means any progress on Brexit is likely to add a little more complexity to the current conversation with the EU.
Add in the possibility that we might see the current government fall and the prospect of a new election which could augur in an anti-business Labour government and the risks for the pound are evenly split, between a retest of the 1.3600 level and a sharp drop below 1.3000 towards the 1.2000 lows.
Equities
Equity markets continued where they left at the end of 2016 as economic data from across the globe showed strong signs of picking up and accelerating with both soft and hard data indicators posting numbers of varying degrees, coming in at multi year highs, with the Nikkei 225 and S&P500 leading the way higher.
What is a little worrying is that European markets have started to diverge away if we look closely at the DAX and EuroStoxx50 there could be about to roll over despite their impressive gains so far this year.
Part of this is probably down to a rising euro which along with the pound has outperformed the US dollar this year. If this trend continues then markets in Europe could continue to lag behind in 2018.
As in 2016 markets got off to a slow start with most of the gains this year coming in the second part of the year, with the Nikkei 225 hitting its highest levels since 1996, while the DAX, S&P500 and FTSE100 all posted new record highs, although the FTSE100 has been a bit of a laggard overall.
Central banks
The inflation fairy was also expected to return in 2017 and for a while it did before prices peaked in the first quarter and have since slid back. What we’ve seen since then is short rates rise and long rates fall in what bond markets appear to be pricing is a more benign long term inflation environment. This flattening of the yield curve would appear to suggest that the longer term equilibrium for interest rates is likely to be much lower than in the past. One of the reasons is likely down to the fact that total debt is much higher and that will likely constrain global demand. Furthermore global GDP growth has been much better in 2017 than we had originally thought it would be at the end of 2016, which means that we could be overestimating GDP growth for 2018.
Bond markets would appear to be suggesting that this could well slow in 2018 in which case expectations for further rate rises from the US Federal Reserve and other major central banks are likely to be pushed further out into the end of the decade.
Much will depend on expectations surrounding monetary policy and while US rates are expected to rise further there remains very little clarity on how many rate increases we’ll get next year when Jerome Powell takes over at the Federal Reserve. This is because we still have no clarity on who will be taking up the three vacant Fed governor positions, all of which will be Presidential appointees. Given President Trump’s problems, he’s unlikely to want to appoint anyone too hawkish, lest they prompt a rebound in the US dollar, which suggests markets may be overestimating the number of US rate rises for next year.
What we can look forward to is a US central bank that has undergone a significant upheaval at the top, a new leader in Jerome Powell, as well as the prospect of at least another four new appointments. We’ve already seen two Trump appointees in the shape of Randal Quarles, as vice chair for bank supervision, and Marvin Goodfriend, both of whom we know relatively little about.
Mr Quarles has warned about risks to financial stability from bitcoin and other cryptocurrencies, while other public utterances would appear to suggest he favours looking at a fresh look at current banking regulations, something new Fed chair Jerome Powell has also suggested might be worthwhile.
There has been some speculation that Mr Goodfriend might well lean to the more hawkish side when it comes to interest rates, given Donald Trump’s distaste for low rates before he was President.
This narrative has undergone a shift since he became President as several outbursts about the strength of the US dollar this year will testify. As such it would be surprising if the President were to knowingly pick a Fed board member who could then cause future problems for him by pushing the US dollar back up.
Other risks to consider are Italian elections which if history is any guide will probably be a damp squib given expectations around France and the Netherlands a year ago. That being said there is a much bigger eurosceptic fringe in Italy than elsewhere in Europe, and eurosceptic party 5 Star are ahead in the polls.
A slowdown in economic growth as well as a continued failure to deal with the dysfunctional Italian banking system also remains a tail risk.
We also have the background noise of the Brexit talks as the talks look to progress to matters of trade. A breakdown in talks can by no means be ruled out, along with a collapse of the UK government which might bring about the prospect of an anti-business Labour administration, which could prompt a run on the pound and large scale capital outflows.
Jason Martin, Investing.com - Bank of England
The Bank of England is a bit of an outlier in this trio of central banks. While the BoE faces a similar problem of low wage inflation, it is the only one of the three who has seen headline inflation soar past and remain far beyond its target, placing a serious squeeze on households’ cost of living.
Although the BoE eventually undid the rate cut implemented after the UK voted to leave the European Union, its policy makers remain reluctant to make further moves in tightening monetary policy due precisely to the uncertainty surrounding the Brexit negotiations.
The bank’s Monetary Policy Committee insisted in its December meeting that inflation had peaked at its most recent reading of 3.1%.
At the moment, markets do not expect the BoE to raise rates again until towards the end of 2018, when it will add another 25 basis points.
Jeroen Blockland - Playing in extra time
A number of financial and macro-economic factors indicate we are now late cycle.
First, credit growth has accelerated quickly in recent years and has reached elevated levels. China offers the best example of unsustainable credit growth with private sector debt-to-GDP reaching 220%.
Second, credit quality has deteriorated. Leverage ratios have gone up, while the percentage of covenant-lite bonds issuance has risen sharply.
Third, unemployment rates are down to multi-year lows around the globe.
While we are now in the later stages of the economic cycle, we start 2018 with the strongest economic momentum in years. We have also reach a stage where monetary policy is clearly too loose given economic circumstances. China’s deleveraging phase puts China high on the big risk list once again.
Strong economic momentum and too loose monetary conditions pose risks for government bonds. Yields are likely to rise and at current extreme levels of interest rates government bonds offer no protection whatsoever.
Because of the massive bond rally since Volcker aggressively rose rates to curb inflation almost 40 years ago, bond investors have forgotten that government bond returns are negative almost 20% of the time. Given the fact that real rates are much higher in emerging countries we favour emerging debt over government bonds.
Credits are expensive, with credit spreads hitting pre financial crisis lows. However a positive economic environment combined with a massive amount of liquidity can keep spreads at these suppressed levels if not lower. But this comes with an increased risk of an unexpected credit event, for example in high yield.
Finally, momentum in equities is strong and should carry into 2018. Earnings growth should take over from multiple expansion as the main driver of return as valuations are elevated, especially in the US. Faster wage growth and a gradual end to global QE could prove to be a challenge later on. We favour Japanese equities (very strong earnings momentum and ongoing buying by the BoJ) and European equities (leverage on global growth and relative attractive valuation) over emerging markets and US equities.
Clement Thibault, Investing.com - Stocks in never-before seen territory
When looking at the stock market in general, I believe we're in borderline, never-before-seen territory. The only two red month this year for the S&P were March and August, when the S&P lost 18 and 6 points, respectively. That’s -0.7% and -0.2% for the worst months of the year. The Dow is up 25.4% in 2017, while the S&P is up "only" 20.1%.
Amazon (NASDAQ:AMZN), Facebook (NASDAQ:FB) and Netflix (NASDAQ:NFLX) are all up over 50% this year. That type of double-digit growth is unusual for larger, mature companies, which each of these is… they’re clearly past their start-up phases. So expectations related to promising, early stage growth prospects cannot account for the tremendous increase in their share prices. To each company its own reasons, of course, but they all indeed continued to grow over the year. Of course, the Tech sector in general enjoyed positive momentum and sentiment throughout the year, which helped propel market leaders higher.
Overall, however, the market seems stretched. The last uninterrupted bull run took place from 2012 to 2014 and was the result of a recovery following a crash. This isn't where we are now. I believe we will witness a 15-20% correction in the first half of 2018. Corrections are, after all, a natural part of every market cycle, regardless of any reforms enacted by the Trump administration.
However, I do not see an apocalypse scenario on the horizon. The U.S economy does seem to be strengthening, albeit slowly. As well, the closest thing we've had to a correction this year was a 3.25% drop in March. So it’s inevitable that this impressive no-real-correction streak will come to an end. Afterwards, the reasonably expensive tech stocks (such as FB or GOOG (NASDAQ:GOOG)) will be one of the most attractive investments for the second half of the year.
Ellen Wald - Global oil demand set to grow
OPEC will continue its production cut agreement with its non-OPEC partners at least through June and likely through the year. However, we should expect that some countries will continue to cheat and overproduce, as usual. Other countries, however, will struggle to produce at their quota levels. Because some countries will under-produce, Saudi Arabia may produce more than it has recently, but it will still stay within its quota. Russian oil companies will overproduce as well, but the country will likely try to present an image of compliance with the agreement.
Global demand is expected to grow–a sound assumption barring a serious drop in the global economy. The industry obviously wants oil prices to rise, but Saudi Arabia and some of the other Gulf countries do not want the prices to rise much above $60 (and not above $70) because that could hurt the global economy and global demand.
In the U.S. shale industry, we may see more market divergence. Some companies will struggle to raise needed capital and may be forced to sell assets or merge. The better capitalised shale enterprises with better shale assets will benefit as long as oil prices do not drop markedly. The big question for the U.S. shale industry in 2018 will be whether higher oil prices increase investors’ appetites for shale opportunities or whether investors will demand returns, not just growth.
In the electric vehicle (EV) sector, expect more scepticism of the viability of current EV business plans. Expect rumours of much lower adoption projections than those we have seen over the last few years. Unless we see a breakthrough in technology, more analysts may lose patience and begin to doubt the ability for engineers to develop truly revolutionary batteries. It is likely that more environmentalists will express concern about the environmental impact of producing and charging powerful lithium-ion batteries. Look to Tesla (NASDAQ:TSLA), Volvo (LON:0HTP), and other companies with significant EV plans to see where this phenomenon is going. If one of these companies tempers its projections for EVs, it could mean the idea is not ready for the mainstream consumer.
Jesse Cohen, Investing.com - Shale Derails OPEC, Powell Tested, Bitcoin Pops Then Drops
Rising U.S. shale oil output will derail OPEC’s ongoing efforts to rid the market of excess supplies and prevent prices from rising much further next year, with crude futures forecast to trade in the $55-to-$65 range.
Domestic U.S. oil production has rebounded by almost 15% since the most recent low in mid-2016 to around 9.7 million barrels per day at current levels, the highest since the early 1970s and close to the output of top producers Russia and Saudi Arabia. Increasing U.S. drilling activity for new production means output is expected to grow further, as technological innovations at U.S. shale oil companies make it cheaper for them to produce.
On the Fed front, Jerome Powell, who will take over as chair of the U.S. central bank when Janet Yellen's term ends in February, will be tested early as economic data stateside starts surprising to the downside and growth prospects begin to dim. That could lead Powell to reverse the current plan to wind down the Fed's $4.5 trillion balance sheet in order to support the economy.
Finally, Bitcoin will continue its jaw-dropping rally into the early part of 2018, with prices peaking at around the $60,000-level, before Russia and China partner up to sideline the cryptocurrency. That move sparks an epic crash, taking Bitcoin prices back down to the $1,000-$2,000 range.
Fawad Razaqzada - Safe haven commodity comeback
The recent upsurge in Bitcoin and other cryptocurrencies may have had a direct impact on precious metal prices, if one can assume they are viable substitutes for paper gold and silver.
Like a herd, market participants have a tendency to follow the money. So when Bitcoin goes up in value by hundreds, if not thousands, of dollars per day, the fear of missing out (FOMO) kicks in and speculators rush to buy the cryptocurrency because they don’t want to be left out. Often they fund these positions by liquidating their assets elsewhere, especially those which have been underperforming. With gold and silver failing to make any good progress for months, if not years, this is why I think precious metals have been undermined by Bitcoin as investors have made better use of their funds. But whether a big bubble is being formed in Bitcoin and when that might deflate, no one knows. However, one thing is for sure: Bitcoin will never be gold or silver, whatever nominal value it might attain. Bitcoins can easily be hacked, deleted by mistake, and potentially go back to zero when there is a significantly better substitute available. In contrast, gold and silver represent physical stores of value that cannot and will never go to zero.
The other problem for precious metals is that at the moment they are being overlooked, not just because of the ongoing hype for cryptos but also because of investors’ insatiable appetite for risk as the global stock indices continue to hit multi-year or record highs almost on a daily basis. In addition, precious metals are denominated in the dollar, which has managed to rebound in recent days after falling for much of the year. But if Bitcoin and/or Wall Street crash soon, then the safe haven commodities should make a comeback.
Other factors that might help support gold and silver include, among other things, geopolitical risks, inflation, and a sustained increase in physical demand or restriction in supply. These factors are near impossible to predict. But, ultimately it will be the direction of the dollar and stock markets that gold and silver investors will need to concentrate on the most going forward. While a rebound in the dollar would be bad news for precious metals, it is likely that the stock markets will correct themselves at some stage. When this happens, the appeal of safe haven precious metals will rise.
Now read Part II for contributor thoughts on Gold, Silver, Oil, USD, Euro and Central Bank Policy.