Risk asset temptation
Investors have enjoyed a quiet year in 2017, with few bumpier spots, overall record-low volatility and nice returns. Moving into 2018, the temptation for risk assets is still high. The economic environment remains strong. In the US, the expected fiscal reform and infrastructure spending should provide a renewed support to an economy that remains buoyant. In the Euro area, employment is rising at the fastest rate in a decade, and robust data point to a continuation of a recovery into 2018.
Strong momentum has also been recorded in Japan, and a reacceleration in EM economies is under way, although with differences seen on a country-by-country basis. A revival in global capex is an emerging theme, that could further support the equity markets, as are the stimulative US measures not fully discounted by the market. So far, Central Banks (CB) have maintained an asynchronous rythm, that has allowed the market and the real economy to absorb the very gradual tightening of the Federal Reserve in an orderly manner. But, a “Goldilocks” future is priced into financial markets, so any sign of economies overheating (inflation, wages), or the perception that CB are behind the curve, could lead to sharp corrections in interest rates and volatility in risk assets.
Finally, geopolitical ‘noise’ will continue to be an issue. In this context, investors should resist the temptation to aggressively increase risk. While remaining constructive on risk assets, we expect that 2018 will not be a linear year (directionally positive) like 2017. We see multiple phases in the market, which could change over the course of the year. The economic sweet spot will likely end up in higher interest rates, therefore reducing windows of opportunities in the most crowded areas of the market. Expensive valuations across the board, areas of complacency, liquidity conditions, the challenges ahead in terms of interest rate normalization, and geopolitical risks could result in a very uneven market performance. So, investors should be prepared to deal with a scenario of asymmetric distribution of gains and losses: focus on rigorous risk control strategies, search for quality, increase liquidity in portfolios, pursue effective risk diversification, and consider that multiple possible scenarios could materialize.