Review of 2017 Outlook

Each December, we review the resolutions published the year before and hope that we have had some success. This year our predictions have – once again – proved to be sound. The scorecard is set out below. For 2018, we certainly cannot guarantee to be as accurate as we have in previous years, but hopefully our predictions are thought-provoking and provide a summary of where we think the best opportunities in financial markets are to be found.

  • Moz Afzal Global Chief Investment Officer

    Moz Afzal Global Chief
    Investment Officer

  • Moz Afzal Global Chief Investment Officer

    Stefan Gerlach Chief Economist

  • Moz Afzal Global Chief Investment Officer

    Daniel Murray Deputy CIO and
    Global Head of Research

1 Correct

Continue to believe in global growth

We made four main predictions for global growth: there would not be a developed world recession; that OECD growth would be just over 2%; that the US would be the fastest growing developed economy; and that the divergence between economies would widen out in 2017 compared to 2016. Although the final data are not available, all four of those predictions look to have been correct.

2 Correct

Trumponomics won’t deliver 4% growth

Expectations of what Trump’s policies could deliver were running high in late 2016. We were sceptical and thought his aim of delivering 3.5% to 4% economic growth in 2017 was unattainable. Growth is likely to have been 2.5% - respectable, but below Trump’s objective.

3 Incorrect

Still prefer the US dollar

We expected a further modest appreciation of the US dollar’s value (on the basis of its trade-weighted
index, DXY) whilst expressing concern about the fact that the dollar had become overvalued. The dollar
weakened according to its trade weighted index.

4 Correct

Oil price unlikely to move above US$60-65 per barrel

We expected the oil price to be capped at US$60-65 per barrel. From a low point of US$45 per barrel in mid-year, the price rose to a peak of US$64 per barrel by mid-November and was just below that level on 1 December 2017.

5 Partly correct

Sterling weakness

We expected sterling to be weaker. It was weaker against the euro (it fell from €1.17/£ at the start of the year to €1.13/£ on 1 December) but it appreciated against the US$ (from US$1.24/£ at the start of the year to US$1.34/£ on 1 December). On its exchange rate index, it was broadly unchanged in the year.

6 Correct

Politics: expect the unexpected

We thought it prudent to expect the unexpected in politics. That was certainly the best approach. We thought Trump’s election pledge to impose punitive tariffs on cheap imports would be dropped. It was.

7 Correct

Don’t expect a decisive turn in the trend of bond yields

We did not expect a decisive turn in the trend in bond yields. We thought US and developed world bond yields would continue to trade at low levels in quite narrow trading ranges. The US 10-year government bond yield ranged from 2.05% to 2.61% during the year. Other major markets behaved in a similar way.

8 Correct

Prefer emerging market to high yield bonds

We saw better opportunities in emerging market sovereign bonds than in corporate high yield bonds in 2017. The total return from emerging market bonds was 8.6% in US$ terms in the year to 1 December, above that from high yield bonds (7.1%).

9 Correct

Sector rotation

Sector rotation was a theme. We saw good opportunities in US healthcare and biotech. The healthcare sector did indeed do well, outperforming the S&P 500 index.

10 Correct

The Rising Sun

A similar conclusion applies to our call on Japan, which we thought could be one of the best performing stockmarkets. The market did well, and even though it was not the best performing region of the world, in US$ terms the Japanese equity market outperformed the MSCI World index.

Global Growth Matures

Global growth is set to continue in 2018 at a similar pace to that seen in 2017. Risks of a slowing later in the year cannot, however, be ignored.


We see global gross domestic product (GDP) growth continuing in 2018 at around the same rate as in 2017, 3.5%.1 That overall rate combines the advanced economies, which are likely to grow at just over 2%, and the faster-growing emerging economies (China, notably, should still grow around 6-6.5%). That measure of growth has been quite stable for five years or so now. Expectations of its continuation at a similar rate are supported by, for example, the global Purchasing Managers’ Index which remains well above the 50 level (see Figure 1).

In the US, we expect GDP growth of around 2.5% in 2018. The economy clearly gained momentum in 2017, with annualised growth above 3% in the second and third quarters. Tax cuts should help growth in 2018, through increased household disposable income and potentially greater corporate investment spending.

We doubt the world will face another recession in 2018, but there are risks of a slowdown as the year progresses. These risks come in three areas. First, capacity constraints: in several developed economies, notably Germany and Japan, there are shortages of skilled labour, constraining the ability to grow in certain sectors. Second, risks emanate from too sharp a tightening of monetary conditions. Although the US Federal Reserve’s exit from quantitative easing has been well choreographed it remains to be seen how it works in practice. In China, the tightening of conditions in the shadow banking sector is another uncertainty. Third, a shock, maybe of a geopolitical nature, can neither be ruled out nor, of course, predicted.

Overall, however, the outlook for growth remains one of steady expansion.

1 The measure used here weights together the growth in different economies according to purchasing power parity (PPP), rather than actual, market exchange rates. As PPP rates are normally higher than market exchange rates for emerging economies such as China, it gives a greater weight to these countries. At market exchange rates, overall global growth is set to be around 3%.

1. Steady for now

Steady for now

Monetary policy divergence

Monetary policy will head in different directions. The Bank of Japan and the European Central Bank (ECB) continue to expand their balance sheets; UK on hold; Fed runs down its assets. US will raise rates, with Fed Funds rate potentially reaching 2.8%, but not until 2019.


In Japan, the central bank’s balance sheet is on track to become larger than the overall economy in


The major central banks around the world will take different paths on monetary policy in 2018. The US has a well-choreographed path for running down the assets which it acquired under its quantitative easing programme. That will involve scaling back the amount of its maturing (US Treasury and mortgage-backed) bonds which it reinvests. The consequence will be a reduction in the size of its balance sheet, both in absolute terms and relative to GDP (see Figure 2).

One concern is that this may raise long-term bond yields. The Fed estimates that 10-year US Treasury yields are around 50-150 basis points lower than they would have been in the absence of the Fed’s asset purchases. 2 But not all the asset purchases will be reversed; and the rundown which does take place will take several years. We doubt that the impact on long-term interest rates will be substantial. With US inflation still low, and expected to remain so, and with the Fed’s longer-term projection for a Funds rate of 2.8%, US long-term bond yields will remain well anchored.

The Bank of England has no current plans for buying more assets in 2018, or running down assets it already owns.

The ECB will continue to purchase bonds, albeit at a slower rate than in 2017. In 2018 it may well come close to the limit of what it can own in some markets. However, no Greek bonds have been bought by the ECB so far. That may change in 2018: Greece should exit its rescue programme in August; and even before that, recently-issued covered bonds may be judged sufficiently creditworthy for purchase by the central bank. The ECB is unlikely to raise interest rates in 2018, although it may indicate rates will start to rise in 2019. As ECB President Draghi’s term of office lasts until October 2019, raising rates could well be a task for his successor.

In Japan, the central bank’s balance sheet is on track to become larger than the size of the overall economy. That will, we think, lead to a weaker yen.

2 https://www.federalreserve.gov/econres/notes/feds-notes/effect-of-the-federal-reserves-securities-holdings-on-longer-term-interest-rates-20170420.htm

This is an attractive alternative to the standard financial ‘hub and spoke’ model in which with data are stored centrally.

2. Up, down and sideways

Up, down and sideways

Yen: Weaker again

The Bank of Japan’s monetary policy is set to remain very easy in 2018. We think that will lead to a weaker yen.


When ‘Abenomics’ was first launched in late 2012/early 2013 a key aspect was the quest to achieve 2% inflation. The sharp weakness in the yen which followed the policy announcement (see Figure 3), coupled with a rise in the sales tax from 5% to 8% in April 2014, meant that the 2% inflation target was, temporarily, achieved. But as the yen strengthened again (and the effects of the sales tax rise dropped out of the inflation calculation) inflation has fallen back. The headline inflation rate, including all consumer prices, is now 0.7% year-on-year; excluding food and energy prices it is just 0.2%. 3

We think that points to a potential increase in the purchases of long-dated government bonds in a commitment to keep 10-year bond yields at 0%. That means the Bank of Japan’s policy will continue to diverge from that of other central banks. We expect this will drive down the value of the yen further. Historically, after sharp changes in the value of the yen, the currency tends to remain in a broad trading range for a while. We think it may well do that again: after initial weakness, it could stabilise in a range of ¥115-125/US$.

That will help Japanese companies’ profitability but, even without such help, we remain positive on Japanese equities. They trade on attractive valuations and corporate reform, the third feature of Abenomics (after 2% inflation and fiscal reform), is progressing, albeit slowly.

3 Source: Thomson Reuters Datastream as at 27 November 2017.

3. Back down?

Back down?

Tax Reform

US tax cuts should eventually materialise in 2018. Although welcome, the implications for the economy and stock market will lie more in the fine detail.


In late 2017, optimism that US tax cuts will finally materialise in 2018 was running high. If the US does succeed in reducing the main corporate tax rate to just 20%, it will successfully leapfrog many other countries. Amongst the major economies, only the UK, with a 19% rate, would be lower (see Figure 4).

The impact on corporate earnings should be significant. On the basis of our assessment of the most likely tax package, S&P 500 corporate earnings could well increase by more than 10% in 2018 (compared to 7% in the case of no tax cuts).

However, tax rates actually paid by companies have rarely been as high as 40%. Effective tax rates have been lower in some sectors, notably technology and healthcare, where a higher proportion of earnings comes from overseas; and closer to 40% in more domestically-orientated industries. Nevertheless, companies with retained profits held abroad are set to benefit from a favourably low tax rate on the repatriation of overseas earnings.

Personal tax rates are also set to be reduced although, here also, the effective change will depend on offsetting changes to allowances and deductions.

Overall, however, US tax cuts are set to be a boost for corporate earnings and economic growth in 2018.

The impact on corporate earnings should be significant.

Republican plan: a corporate tax rate of


If that happens, then, amongst the major economies, only the UK would have a lower rate of


4. US leapfrog

US leapfrog

China cleans up

2018 will be a year in which China cleans up: on the environment, in the banking sector and in the continuing fight against corruption. China will become ever-more investable.


The degradation of the environment has long been recognised as the unfortunate side effect of China’s rapid economic growth over the last four decades. But China is making substantial progress in tackling the problem. Anecdotally, recent visitors to Beijing comment on the improved air quality. Hard data support that impression (see Figure 6). Equally, there is much further to go. Cutting capacity in heavy industries – steel, cement and glass – which are the biggest polluters is the key to progress. But China is also a leader in new, cleaner technology. China has more installed wind power than all the EU and twice the amount of the US. 4 More electric cars were sold in China last year than in the rest of the world combined. And in Beijing the bicycle, in its new app-controlled, GPS-linked, on-demand version is enjoying a revival. 5

Easy credit availability, especially via the shadow banking sector, is also being tackled. No longer will sponsors be able to advertise ‘guaranteed’ double digit interest rates on wealth management products. As they have often been used to provide the financing for construction projects, some of those will be cut. The government now has a greater tolerance for the slower economic expansion that may result.

China will make further progress in tackling corruption in 2018, we think. 6 This is the key, in the long-term, to putting growth on a firmer foundation and making China an even more investable market. Reflecting this, further progress is set to be made in including China’s mainland equities in global indices.

4 Source: Global Wind Energy Council. www.gwec.net.
5 A revival which is too successful, according to some. See Reuters China‘s sharing app boom floods sidewalks with bicycles.
6 Transparency International ranked China as the 79th least corrupt economy in the world in 2016, compared to 100th in 2014.

5. Fresher air

Fresher air

Credit Market

We like the yield gap between long-dated and short-dated investment grade US corporate bonds.


We like the opportunity provided by the yield spread (relative to government bonds) of long-dated US investment grade corporate bonds. Unusually, the spread is much wider than that on short-maturity corporate bonds (see Figure 5).

Indeed, rarely has the gap between the two been as wide as at the end of 2017. At 160 basis points, the long-dated spread is more than twice that for short-dated bonds. Normally, the difference between the two is quite small. Even at the peak of the global financial crisis, when risk aversion was extreme and a preference for short-dated bonds would be expected, long-dated spreads were tighter than those for short-dated bonds.

We think the wide gap reflects a general preference of investors for short-maturity bonds. Their prices are less susceptible to a fall in the event of a general back-up in interest rates and bond yields rising along the yield curve.
However, we think the yield curve is most unlikely to shift upwards by an equal amount across all maturities (a ‘parallel shift’). It is much more likely, in our view, to flatten with long yields rising less than short yields. Long-dated government bond yields are well-anchored by low inflation and modest real growth; and the effect of the reduction in the Fed’s balance sheet is likely to be quite modest. That will provide an anchor for corporate bond yields. Furthermore, the higher coupon payments on corporate bonds, compared to government bonds, provides an added support.

On balance, therefore, we think current market pricing provides an attractive opportunity in long- relative to short-dated investment grade bonds.

Long-dated government bond yields are well-anchored by low inflation and modest real growth; and the effect of the reduction in the Fed’s balance sheet is likely to be quite modest.

6. Like the gap

Like the gap

Discretionary Spending Surprises

The consumer discretionary sector is one which we think can perform well in 2018, as wages pick up and consumer confidence continues to recover. We favour ‘omnichannel’ retailers.


We see good opportunities in the consumer discretionary sector for 2018. The sector lagged the overall world (MSCI) and US (S&P 500) indices in 2017, albeit by a modest amount. US consumer discretionary spending will, we think, recover as economic growth remains on a firm footing, the labour market remains strong, wages pick up and consumer confidence continues to recover. Those broad trends are also in place in many other regions of the world.

Within the consumer discretionary stock market sector a distinction is often made between online retailers (such as Amazon) and others with more traditional businesses based on physical stores. But the most interesting opportunities, in our view, are in ‘omnichannel’ retailers: those that have a physical store presence, an online presence (which increasingly involves app-based functionality) and an integration with social media.

Companies with such a combination of different channels are notably found in the personal luxury goods market. The share of online sales in that market has expanded rapidly from just 1% in 2005 to 9% in 2017 (see Figure 7), fuelled by social media, online advertising and often quickly changing consumer tastes and preferences.

We see the trend towards stronger consumer discretionary spending as both a US and a global one, and favour that sector relative to the US S&P 500 and MSCI World Index for 2018.

7. Online luxury

Online luxury

Bitcoin bubble,
blockchain boom

Whether the Bitcoin bubble bursts in 2018 is hard to predict, as there is no meaningful way of assessing its fundamental value. Blockchain technology, on which Bitcoin is based, is, however, set to move into the mainstream.

Price of one bitcoin: In October 2012... $10
...and December 2017. $17,400

Assessing whether the sharp rise in Bitcoin’s price will be followed by a bursting of the bubble is difficult. What is clear is that periods of very substantial Bitcoin price appreciation have, in the past, been followed by sharp corrections (see Figure 8). Two previous ten-fold Bitcoin price increases each took just 8 months and were followed by substantial price declines. After Bitcoin hit US$1,000 in December 2013, its price dropped to under US$200 in early 2015. Equally, however, the price has recovered after previous setbacks. In 2017, the price of many other crypto currencies rose even more strongly (see Figure 9).

It remains to be seen whether Bitcoin’s rise above US$10,000 in late 2017 will be followed by a similar correction. But the rise of Bitcoin cannot easily be dismissed. Notably, with Bitcoin futures launched on 11 December 2017 on the Chicago Board Options Exchange, it may come to be traded like other commodities.
Furthermore, blockchain, the ‘distributed ledger’ technology which Bitcoin uses, is set to develop further.

This is an attractive alternative to the standard financial ‘hub and spoke’ model in which data are stored both centrally and at individual financial institutions. Blockchain can reduce costs, shortening settlement cycles and freeing up capital. 2018 will be a critical year in determining whether blockchain’s potential can be realised.

8. Blowing bubbles

Blowing bubbles

9. Crypto currencies

Crypto currencies

Dr Copper & Co.

“Dr Copper” – the trend in the metal’s price and demand for it – has long been used as a leading indicator of global economic activity. With the growth of electric vehicles, Dr Copper may find a new business colleague in 2018.


Copper is regarded as one of the most economically sensitive metals because of its wide range of uses: from wiring and copper piping to electronics and industrial applications. For this reason, a rise in the copper price is often seen as a sign of increasing industrial activity. Historically, movements in the copper price have been a helpful indicator of future economic prospects. In that sense the rise in the copper price which started in mid-2017 is a sign that global growth will continue in 2018.

The prices of other metals, however, may now come to be regarded as a more modern version of Dr Copper. Lithium, nickel and cobalt are all used in the production of batteries, for electricity storage in general and for electric vehicles in particular.

In that sense, we see the sharp rise in the cobalt price (see Figure 10) as providing support for the view that the adoption of electric (and hybrid) vehicles will be quite rapid.

We do see the rise of electric vehicles as a fundamentally important trend for the global economy. Although it is impossible to predict the take-up of such vehicles with accuracy, we remain optimistic. Despite much attention being focused on US companies in this industry, we think China’s strength has been under-appreciated. To take advantage of what we expect to be a significant global trend, we favour exposure to battery makers and Chinese companies which are often under-recognised key participants in this new trend.

10. Dr Copper & Co.

Dr Copper & Co.

Fifteen-hour week?

The 15-hour working week with ample leisure time, envisaged by John Maynard Keynes, is far from reality. Is there any prospect of that being achieved? Only with a more equal distribution of income.


In 1930, Keynes thought that the 15-hour working week would become a reality in 100 years. 7 Technological progress would be so great, he thought, that there would be no need to work any longer than that. The problem would be to find enjoyable ways of filling much-increased leisure time.

Keynes’ prediction was based on an expected eight-fold increase in productivity - output per hour. On that, he was broadly correct. 8 It has not, however, translated into shorter working hours. In the US, the average workweek has been broadly unchanged for forty years. It is the case that countries with a higher GDP per head tend to work shorter hours (see Figure 11) but none are near to a 15-hour average.

There are several explanations for why the improvement in productivity has not translated into shorter working hours. First, work can give people a sense of purpose. Second, work can give people a sense of community and belonging. But the third explanation is the most convincing: that productivity improvements have not been shared equally. They have led to higher corporate profits and incomes for the highest earners, whereas median household incomes have been stagnant, notably in the US (see Figure 12). In a recent research paper, 9 this latter explanation is found to provide the most convincing explanation of why the work week remains so long. The conclusion is that a more equal distribution of income would allow more leisure time. Although that is unlikely to happen in 2018, it is set to be one of the most important issues which needs to be tackled in the years to come.

7 J M Keynes, ‘Economic Possibilities for our Grandchildren’, in Essays in Persuasion (New York: Harcourt Brace, 1932), 358-373.

8,9 Ben Friedman, ‘Work and consumption in an era of unbalanced technological advance’, Journal of Evolutionary Economics, April 2017.

Keynes’ prediction was based on an expected eight-fold increase in productivity - output per hour.

11. Work, work, work

Work, work, work

12. It's tough being in charge

It's touch being in charge


Term in full
  • ECB
    European Central Bank
    The ECB is the central bank for Europe's single currency, the euro. The euro area comprises the 19 European Union countries that have introduced the euro since 1999.
  • ETF
    Exchange Traded Fund
    An ETF is an investment fund traded on a stock exchange. ETFs are typically passively managed to track a particular stock or bond market index or sector.
  • GDP
    Gross Domestic Product
    GDP is the monetary value of all the nal goods and services produced within a country’s borders in a speci c time period. GDP is usually calculated on a quarterly basis.
  • OECD
    Organisation for Economic Co-operation and Development
    A group of 35 member countries, including many of the world’s advanced countries but also emerging countries such as Mexico, Chile and Turkey. The members of the group work together to discuss and develop economic, social and environmental policies.
  • QE
    Quantitative Easing
    QE is an unconventional form of monetary policy where a central bank creates new money to buy nancial assets, like government bonds. This process aims to directly increase private sector spending in the economy and return in ation to target.
  • SOEs
    State Owned Enterprises
    Enterprises where the state has signi cant control through full, majority or signi cant minority ownership.