RPT-COLUMN-The boldest market call for 2018? The consensus: McGeever
(Repeats Friday’s story without changes)
By Jamie McGeever
LONDON, Dec 8 (Reuters) - Credit markets should brace for a U.S. recession, the U.S. yield curve will invert and growth in America will reach President Trump’s lofty and oft-derided target of 4 percent.
These are just some of the more eye-catching 2018 calls from analysts at many of the world’s big banks. Yet paradoxically, the biggest shock of all may be that next year is another ‘Goldilocks’ year like this year. In other words, the consensus.
That would be a benign mix of strong global growth, chunky corporate profits, low market volatility, a gentle drift higher in bond yields, and the continued “melt up” in stocks.
In many respects, 2017 has confounded even the most bullish forecasts. World stocks are up 20 percent, global growth its strongest since 2011, bond and stock market volatility the lowest on record and “junk” bond yields at all-time lows.
Aside from the market corrections and bouts of volatility that characterize any given year, analysts broadly reckon 2017 will seamlessly merge into 2018. The pace of change in some markets may vary, but essentially the song will remain the same.
But can it?
The biggest single driver for markets this year (and the last several) was central bank stimulus. The Fed may be raising rates and about to wind down its balance sheet, but the European Central Bank and Bank of Japan more than filled the void.
According to analysts at Deutsche Bank, quantitative easing from the world’s major central banks hit a post-crisis peak of $182 billion a month in March this year. That will shrink to $53 billion by the end of next year and flip to outright liquidity withdrawal in mid-2019, they predict.
The oceans of central bank liquidity that have lifted all markets is drying up. What will replace it?
Global growth is on such a tear that many economists reckon it doesn’t need central bank rocket fuel. Consumer demand and business investment will be strong enough to keep the world economy expanding at a rate of around 3.5 percent - an impressive enough pace on its own, especially this late in the economic cycle.
“A self-enforcing economic cycle,” say Barclays economists, predicting 4.0 percent global growth next year, a conspicuous figure also forecast by BNP Paribas for U.S. growth in the second quarter.
There’s no shortage of potential banana skins though. Firstly, it’s been over a decade since the world experienced a global monetary policy tightening cycle.
If the last decade of extraordinary policy was an experiment - some 700 interest rate cuts, according to JP Morgan, $8 trillion of QE stimulus, according to Deutsche Bank, and negative interest rates - then reversing it, however carefully, is surely an experiment too.
“The great unwind, which has recently begun, is likely to prove to be anything but straightforward,” JP Morgan warns.
LETHAL MIX
It’s a well-worn argument but the example of Japan cannot be ignored. The Bank of Japan has been battling deflation, low growth and fallout of the property and stock market crashes for nearly quarter of a century.
It first adopted zero interest rate policy in 1999, started QE in 2001 (implementing various versions since), unveiled its “yield curve control” policy this year and has been one of the most interventionist central banks ever in currency markets.
Exiting and reversing these policies has proved challenging. The BOJ thought the coast was clear and raised interest rates in 2000 and 2006-07, but both turned out to be policy mistakes.
BOJ governor Haruhiko Kuroda is now highlighting the risks of easing policy further, signaling that rate hikes might not be too far off. With global debt higher now than it was even before the 2008 crash, tighter policy globally carries clear risk.
Secondly, the economic expansion is long in the tooth. In the United States it’s been rolling for over 100 months in a row, and by the time 2018 comes around will be closing in on the record 120 months in the 1960s.
It’s said that economic expansions don’t die of old age, instead they’re killed by the Fed. Here, both elements are in play - the cycle is mature, and the Fed is raising rates and about to start shrinking its balance sheet.
Should tighter monetary policy take the wind out of the economy’s sails, the remarkable strength of corporate profits this year is unlikely to be replicated next year.
For financial markets the earnings recession of 2016 was mitigated by central bank largesse, and this year stocks on both sides of the Atlantic enjoyed earnings growth of at least 10 percent. Next year, earnings won’t be as strong and central banks are taking away the punch bowl. It could be a potent mix.
Thirdly, expect higher financial market volatility.
Like the economic cycle, markets have been on a roll for years - Wall Street troughed in March 2009 and has barely seen a correction of 10 percent (far less a 20 percent drop) since, the much-anticipated bond market implosion hasn’t happened and the price of high yield bonds has never been higher.
Analysts disagree on whether and by how much markets are overvalued. Blackrock, the world’s largest asset manager, is among those who argue that stock market valuation metrics such as the Shiller price/earnings ratio are no longer valid, and that the bull run can continue for several more years yet.
But others are wary, and argue that bubbles are forming in certain parts of the equities universe to join those in high yield credit and bond markets.
Low volatility has underpinned the market surge this year. The VIX index, which measures implied volatility of the S&P 500, hit a record low below 9 percent last month and its average for the year is the lowest annual rate on record.
This has ensured 2017 will go down as the calmest year in U.S. market history. According to Charlie Bilello at Pension Partners in New York, 95 percent of all trading days on the Dow this year have had an intraday range of less than 1 percent.