This is an excerpt from our most recent Economic Outlook report. To access the full PDF, please click here
2017 was characterized by a rare occurrence of solid economic growth with a tightening labor market below the level of natural employment. Somewhat surprisingly, very low inflation levels and record low volatility in equity markets accompanied the solid growth.
Whether and how long this Goldilocks scenario will persist throughout 2018 will depend on a number of factors.
We want to highlight the most important ones, from our point of view:
1) Interest Rates: We view the development of the yield curve as a driving force for the overall health of the market in 2018. While recent weakness in long-term yields fed into the notion that a yield curve inversion might be imminent in the near future, we remain optimistic that long-term rates will rebalance throughout 2018.
With the global economy improving we expect rising interest rates outside of the U.S. This will subsequently reduce demand for US Government bonds and will provide long term yields some upward room to breathe. We also expect the Fed to continue its gradual tightening of financial conditions with 3 more hikes in 2018. They will combine this with a continuation of its balance sheet unwinding. Both of which should provide further upward pressure long-term yields. However, we do expect market volatility to increase as the Fed is reducing monetary accommodation.
2) Capitol Hill: While the effects of the recently signed tax reform on the real economy have yet to materialize, attention is starting to shift already to further policy reform. One of the next challenges will be the passing of an infrastructure package that both Democrats and Republicans can agree on.
Both sides have expressed interest on the topic. The benefits of infrastructure spending (or lack thereof) will typically not be felt immediately but rather over longer horizons like 5 to 10 years. Yet, some of the immediate effects will be the creation of jobs and increased revenue in numerous associated sectors and industries -- such as building materials, raw material suppliers, and engineering services.
3) CAPEX: Capital expenditure has been subdued through this most recent expansion. We expect this trend to end in 2018. This late in the cycle business optimism is rising. We expect that this will lead to increasing capital expenditure this year. This should particularly benefit the info tech sector.
Finally, it remains to be seen how companies benefitting from the newly signed tax bill will use the additional funds (with share buybacks, dividends as the other prominent options). We expect that a significant share will be channeled towards capital expenditure.
4) NAFTA: The trade agreement appeared to have been moved to the backburner of policy reform. It did not receive the public attention that it deserves in our view. We expect that the damage of a failure of an agreement will be hard to overestimate. NAFTA provides companies from all 3 countries with economies of scale, efficient synergies, and competitiveness.
A study conducted by the Boston Consulting Group found a NAFTA withdrawal could put up to 50,000 U.S. supplier jobs in the automotive industry at risk. Other industries such as agriculture would also be highly negatively affected. We expect that a failure to come to an agreement will cause a significant slowdown in GDP growth and investors should pay close attention to the trade talks.
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Economic Outlook for 2018: Will the Goldilocks Scenario Persist?
This is an excerpt from our most recent Economic Outlook report. To access the full PDF, please click here
2017 was characterized by a rare occurrence of solid economic growth with a tightening labor market below the level of natural employment. Somewhat surprisingly, very low inflation levels and record low volatility in equity markets accompanied the solid growth.
Whether and how long this Goldilocks scenario will persist throughout 2018 will depend on a number of factors.
We want to highlight the most important ones, from our point of view:
1) Interest Rates: We view the development of the yield curve as a driving force for the overall health of the market in 2018. While recent weakness in long-term yields fed into the notion that a yield curve inversion might be imminent in the near future, we remain optimistic that long-term rates will rebalance throughout 2018.
With the global economy improving we expect rising interest rates outside of the U.S. This will subsequently reduce demand for US Government bonds and will provide long term yields some upward room to breathe. We also expect the Fed to continue its gradual tightening of financial conditions with 3 more hikes in 2018. They will combine this with a continuation of its balance sheet unwinding. Both of which should provide further upward pressure long-term yields. However, we do expect market volatility to increase as the Fed is reducing monetary accommodation.
2) Capitol Hill: While the effects of the recently signed tax reform on the real economy have yet to materialize, attention is starting to shift already to further policy reform. One of the next challenges will be the passing of an infrastructure package that both Democrats and Republicans can agree on.
Both sides have expressed interest on the topic. The benefits of infrastructure spending (or lack thereof) will typically not be felt immediately but rather over longer horizons like 5 to 10 years. Yet, some of the immediate effects will be the creation of jobs and increased revenue in numerous associated sectors and industries -- such as building materials, raw material suppliers, and engineering services.
3) CAPEX: Capital expenditure has been subdued through this most recent expansion. We expect this trend to end in 2018. This late in the cycle business optimism is rising. We expect that this will lead to increasing capital expenditure this year. This should particularly benefit the info tech sector.
Finally, it remains to be seen how companies benefitting from the newly signed tax bill will use the additional funds (with share buybacks, dividends as the other prominent options). We expect that a significant share will be channeled towards capital expenditure.
4) NAFTA: The trade agreement appeared to have been moved to the backburner of policy reform. It did not receive the public attention that it deserves in our view. We expect that the damage of a failure of an agreement will be hard to overestimate. NAFTA provides companies from all 3 countries with economies of scale, efficient synergies, and competitiveness.
A study conducted by the Boston Consulting Group found a NAFTA withdrawal could put up to 50,000 U.S. supplier jobs in the automotive industry at risk. Other industries such as agriculture would also be highly negatively affected. We expect that a failure to come to an agreement will cause a significant slowdown in GDP growth and investors should pay close attention to the trade talks.