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2018 Outlook

We’re Not There Yet But We’re Getting Closer

The classic signs of the end of a business cycle are not currently evident but we are getting closer. The current macro regime, like all others, will ultimately end when valuations are at preposterous levels, the Federal Reserve is aggressively tightening policy, and/or the U.S. economy is rolling over. We are not there yet. And yet the unemployment rate is low, wages have trended higher, credit spreads are historically tight, and policy rates in 2018 are poised to move higher. Still, we expect 2018 to be a solid year for risk assets. We favor investments outside the U.S., particularly in the emerging markets, which are generally in the earlier stages of their business cycles and where policy is generally accommodative. In the U.S. we continue to favor growth stocks in a still-modest growth world.

Global Landscape

We’ve examined macroeconomic conditions (PMI), policy guidance (interest rates), and current real yields to help you understand some of the most crucial factors for global investing. Explore selected economic and financial data for countries around the world below.

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Regional Views

What risks will tighter U.S. monetary policy pose to the global economy? How do international equities valuations stack up against U.S. stocks? Should credit investors consider adding international exposure, especially to emerging markets?

For answers to all of these questions and more, take a closer look at the investment implications policy and valuations will have on a regional level.

2018 Outlook
  • United States

    Countries 1

    Total GDP $18.5T

    Total Population 323M

    For the first time in nearly a decade, the risks to the global economy are centralized in the U.S., not in other major world economies. We expect the cycle to continue, but the risks are rising as the Federal Reserve (Fed) tightens monetary policy.

  • International

    Countries 20

    Total GDP $24.2T

    Total Population 606M

    2017 was said to be a “make-or-break” year for the Eurozone and the common currency. However, investors paying too much attention to European politics may be under-appreciating the sound economic and earnings recovery taking place across the continent.

  • Emerging Markets

    Countries 23

    Total GDP $25.2T

    Total Population 3.8B

    Emerging Markets (EM) growth continues to exceed expectations since bottoming out in 2016. Led by massive policy support from Chinese policymakers, China’s transition to a service- and consumer-oriented economy has provided a tailwind for EM economies globally.

Policy
  • The current macro backdrop—low unemployment, reasonable wage growth, a stable-to-weak U.S. dollar—is providing the Fed the cover it needs to continue raising interest rates. In addition, the Fed will likely be able to successfully navigate the slow and prolonged process of allowing securities on its balance sheet to mature without reinvesting the proceeds.

    Our base case remains that the cycle in the U.S. will persist, but a tighter monetary stance does not present the best environment for risk taking in U.S. assets.

  • After years of monetary policy support for the rocky European economy, the European Central Bank (ECB) is looking to end its programprograme of continued easing. We expect in 2018 the story of the ECB’s tightening will begin to unfold.

  • Across emerging markets, lower inflation rates are driving continued central bank policy easing, with the notable exceptions of Mexico, South Africa, and China. In China, the biggest risk to the current cycle is tighter monetary policy. Chinese growth will moderate in 2018, in our view, as the focus shifts from “growth at any cost” to long-term structural reform. Credible reforms in China may create very intriguing investment opportunities.

All Cycles End with Inverted Yield Curves, but the U.S. Yield Curve is Steep

Sources: Haver, 4/30/2017. Federal Reserve Bank of New York, Board of Governors of the Federal Reserve. System Open Market Account (SOMA) account as of 5/17/2017.

China’s Economy Is Not Collapsing as Many Feared
  • Deliveries
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  • Cell Phone Users
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  • Online Shoppers
    -
  • Vehicle Sales
    -

Sources:  China National Bureau of Statistics, Haver, 3/31/17.

Valuation
  • U.S. stocks have enjoyed a tremendous rally off their 2009 lows. Naturally, valuations have become stretched and U.S. equities appear expensive relative to their long-term average and the global benchmark. While opportunities remain in U.S. equities, investors should be cautious. The risk in U.S. credit markets, given tight spreads and rich valuations, is higher than it is in equities. In our view, investors should continue to maintain exposure to U.S. credit but proceed with some caution.

  • European equities trade well below their U.S. counterparts on a price-to-forward earnings basis, and offer significantly higher dividend yields. Global investors looking to diversify away from overvalued U.S. equities and credit should consider opportunities present in Europe, where much-anticipated earnings and credit cycles are currently underway.

  • Compelling valuation opportunities exist at a time when many emerging economies have stabilized and expanded. That’s a powerful combination for unlocking the potential reward embedded in EM share prices. Also, EM sovereign and corporate bonds offer better value for global fixed-income investors seeking potentially higher total returns, in our view. The bottom line is those who remain underexposed to international and EM assets may need to rethink their allocations.

Equity
Fixed Income
Current
Average
Discount/Premium

Sources:  Bloomberg, FactSet, 10/31/2017.

Asset Allocation Views

Equities remain the asset class of choice but investors who remain underexposed to international and emerging market assets may need to rethink their allocations. Further, the risk in the U.S. credit markets, given current valuations, is higher than it is in equities. Investors should continue to maintain exposure to U.S. credit but proceed with caution. Here too, international exposure, particularly in emerging markets, may prove beneficial.

FavoredFavoured Equity Assets
Details
Related Funds
Emerging Markets
Developed Markets
Equity - Emerging Markets
Why is this favoredfavoured?

Emerging market equities continue to offer the most attractive valuations.

United States
International
Equity - International
Why is this favoredfavoured?

Developed market equities outside the U.S. are likely to appear more attractively valued as the earnings cycles in Europe and Japan evolve.

Equity - Growth
Why is this favoredfavoured?

In a world where growth is relatively scarce, investors remain willing to pay a premium for growth. Value requires a catalyst (e.g., fiscal stimulus) that we do not believe is imminent.

FavoredFavoured Fixed Income Assets
Details
Related Funds
Emerging Markets
Developed Markets
Fixed Income - Emerging Markets
Why is this favoredfavoured?

With valuations on most sovereign developed-world bonds stretched, emerging market local sovereign bonds and credit offer the most attractive value in fixed income.

Corporate Credit
Treasuries
Fixed Income - Corporate Credit
Why is this favoredfavoured?

With credit spreads tight, the room for price appreciation in high yield is limited. For now, U.S. credit should be viewed as an income-generating investment with some caution.

Short Duration
Long Duration
Fixed Income - Long Duration
Why is this favoredfavoured?

Long duration fixed income assets are still favorablefavourable to short duration given that the current business cycle looks set to continue and interest rates are will likely remain lower for longer in 2018 despite gradual Fed tightening.

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