EXPERTISES - NN Investment Partners

Better and Bumpier

 Photo: NNIP

Photo: NNIP

What will next year look like? We would all like to know and there are good reasons to expect it to be even better. Also, it probably will get a bit bumpier from a markets perspective, but that might not even be a bad thing. It needs to be managed, but also will create some opportunity.

Imagining the future is both fascinating and imprecise. It helps to prepare for the weather of tomorrow, can inspire the start of an innovative start-up and helps preparing for a career through education or parenthood through shared experiences. It might even help to make better choices to guide your financial future. Even the best thought-through expectation of the shape of tomorrow, however, should never be interpreted as a certainty. The only certainty of the future is that it is uncertain.

The weather, the societies we are part of and the economy that creates our income and wealth are all complex adaptive systems. Such systems are not mechanical and future outcomes cannot be calculated by smartly combining a set of input variables. In such systems, there is so much mutual influence between all components that continues feedback loops make the eventual outcome hard to pin down exactly.

It is possible however to make an assessment on the most likely outcome and have some sense of the probability of alternative scenario’s around such a base case expectation. On shorter-term horizons (1 day to a week) weather forecasts have become more accurate over time and provide useful insight in deciding what clothes to wear or what transport to take.

Similarly, current economic indicators, policy and political dynamics and the evolution of our financial market ecology provide help in determining the most likely economic landscape of the year to come.

This is how our expectations for the global economy and financial market behaviour in 2018 should be seen. We are highly convinced that central scenario is the most likely outcome for next year, but will never overlook the uncertainty around that forecast. And when new, differentiating and unexpected information arrives at a later stage, we adapt our thinking, adjust our appetite for different asset classes and reconsider the way we play in markets.

Having said that, how do we feel about next year? As said already, pretty good! The global economy is in its best state in over a decade. The breath of the recovery across regions and sectors is impressive, with finally both emerging markets and investment spending joining the recovery party. In previous years, the economic recovery had been more lopsided as it was mainly driven by developed market consumer demand. The latter is still well supported by further tightening in global labour markets, but more broad-based support for global growth has emerged in 2017.

Especially since limited signs of nearby bottlenecks in the economic system are visible at this point in time. Therefore, modest inflationary pressures will allow for central bankers to remain very gradual in their pace of policy normalization. Heading into the New Year in such a constellation creates a relatively high probability of persistence in these trends for at least another year.

Obviously, it does not mean there are no downside risks to also consider. The behaviour of inflation has been puzzling in recent years and therefore seems more uncertain than ever to forecast. Still, the behaviour of inflation will be crucial for the direction that central banks will take next year. More even than potential political shocks, it seems that unexpected central bank moves create a potential negative risk for the outlook. Higher inflation prints could trigger some hawkish central bank behaviour in the US and the market anticipation of a more hawkish ECB at a later stage as well.

If this more negative scenario materializes, bond yields will rise more sharply and create a negative feedback loop into the real economy.

In our base case, however, markets will do much better. Especially those parts of markets that benefit from better growth ahead. In that respect, cyclical equities stand out. This can be either sectors like financials, industrials or technology. Also, it can be regions that are more cyclical in nature and less progressed in the cycle, like Japan, Europe or emerging markets. Even in this scenario, however, developed market government bond will suffer from gradually rising interest rates in the US. We therefore expect both US and European bonds to struggle to keep their heads above water in 2018. And even if they do, it remains likely they underperform most other asset classes.

Still, also in our central and constructive growth and return scenario, we expect the market environment to be a bit bumpier than in 2017. The uncertainty surrounding underlying inflation and productivity trends, in combination with less predictable behaviour of the Fed will probably invite investor emotions to move around a bit more often.

All in all, we feel the economy will be better and markets will be bumpier, but investment opportunities will still be there for those who look for growth and are able to adapt.


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