Lionel Melin

Lionel Melin

Senior Cross-Asset strategist


Outlook 2018: Heading into extra time

02 Feb 2018

Active Strategies

IS THE BULL FINALLY SHORT OF BREATH?

After an exuberant year in the markets in 2017, just how much higher can they go? Growth momentum looks strong, synchronised, and ready to extend further... yet market valuations are feeling “toppish”, especially with central banks heading for the QE exits.

U.S. TAX BILL TO BOOST CONFIDENCE & CAPEX

Extra time was granted to the U.S. expansion by the fiscal push signed into law in December, and US equities should hit the ground running early in 2018. Companies with relatively high tax rates and mainly US-based revenues should gain the most. We have a preference for domestically oriented names, but also banks and defense stocks. We also keep a slight overweight on US growth stocks: tech heavy, and also better exposed to late cycle performance.

EMU & JAPAN MAY LEAD MEDIUM-TERM GAINS

In Europe, we expect a fully fledged cyclical pick-up in investment. Structures have aged and brighter demand prospects mean corporations should want to exploit cheap financing to refresh their production capacity. In Japan, PM Abe’s government is rumoured to be preparing a fiscal reform package that will heavily incentivise companies to put their cash to work. Eurozone and Japanese stocks, which are enjoying the benefits of ongoing reflation, could outperform their U.S. counterparts - provided that Euro and Yen do not firm up. Political hazards in the eurozone in H1 and the BoJ rate anchoring policy should help with that.

HIGHER YIELDS AHEAD

With regards to inflation, U.S. wage pressures should start to increase due to labor shortages, prompting us to look for entry points into U.S. breakevens early in Q1. However, we expect the overall inflation picture to remain contained, allowing major central banks to proceed with their slow normalization. We expect sovereign yields to drift higher this year and still prefer equities to sovereign bonds, which we rate at slight underweight. We also suggest protecting long U.S. risk asset exposures with a slight underweight on U.S. high yield credit. We are however more constructive on European high yielding papers and especially contingent convertible bonds.

DIFFERENTIATING EMS & LESS $ FUEL FOR COMMODITIES

After a stellar year in 2017, the environment should be less supportive for Emerging Markets this year as US monetary tightening advances and domestic growth pulses moderate. Although controlled, China’s economy – the major driver for the region - still slows down. With selectivity key, we favor Korea, Brazil or Russia equity markets over the likes of Turkey. Commodity producers in particular will benefit from the oil price’s recovery, which should stabilize going forward as the support of a weaker dollar fades and supply balances out demand.

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