In the monthly round-up of our asset allocation views, we discuss the three factors which will determine whether the reflationary environment continues. The most obvious answer is “inflation”. One indicator which suggests that growth (and therefore inflation) could surprise on the upside, is that global trade has been picking up.
24.01.2018 | 12:34 Uhr
For 2018, “3” is the magic number for a reflationary environment to continue.
The most obvious answer is “inflation”. One indicator which suggests that growth (and therefore inflation) could surprise on the upside, is that global trade has been picking up.
Another risk comes from wages. Although wage growth appears to have been unresponsive to tight labour markets so far, research by the Federal Reserve suggests that the Phillips curve is non-linear and when the unemployment rate falls below a certain threshold the relationship between unemployment and inflation will re-assert itself and core inflation will begin to rise.
When we model these two scenarios (“trade boom” and “inflation accelerates”) our global inflation forecast rises from 2.3% to over 3%. From an investment perspective, given market pricing, this outcome would cause volatility in the government bond markets but would also present an opportunity for more cyclically-exposed, value–driven areas of the equity markets to outperform.
A disappointment on the growth front would be more concerning for us. Developed economies are currently in the “expansion” phase, which is characterised by output above trend, growth accelerating and inflation rising. This phase of the cycle is typically benign for equities. The next phase of the cycle is the “slowdown” phase and this is the worst phase for returns.
The challenge is that, at first, the slowdown phase typically feels alright – output is still above trend and, although growth is decelerating, it is still positive. But by this phase equity return expectations and valuations are elevated, leaving room for disappointment and negative returns. For now the traffic light is still green but there are three trends we are watching:
All in all, we continue to be positioned for a reflationary environment with an emphasis on emerging market assets which look relatively cheap. At some point in 2018 however, synchronised global recovery will morph into concerns about synchronised liquidity withdrawal. The real surprise for 2018 could be that we end the year with government bond yields lower than today.