Are we there yet?
Tariq Qaqish, Managing Director—Asset Management at Menacorp, lays down his projections for the second half of 2017.
The longest bull market of over eight years with no meaningful correction and a return of 270 per cent in the S&P 500 is keeping everybody on their toes. We totally understand investors’ reluctance to navigate in such environment as cheap money continues to flow and drive equity markets to all time high. Although unpredictable events such as the election shakings in USA and France, military aggravations between North Korea and USA, and the ongoing Brexit would have shaken the markets, yet all went unnoticed. Despite all of that, and the challenging conditions around the globe, economic outlook is still showing constant signs of growth. So why fight with the market when you can continue to ride the wave until it lasts.
Frequently investors pose the question: when do we expect a market crash? Well Janet Yellen Fed’s Chair and Christine Lagarde IMF’s Managing Director made it less embarrassing for me to answer the question. When speaking during a Q&A event with British Academy President Lord Nicholas Stern in London end of June 2017, Yellen commented: "Would I say there will never ever be another financial crisis? Probably that would be going too far. But I do think we're much safer, and I hope that it will not be in our lifetimes, and I do not believe it will be.”
Lagarde's responded, “I plan on having a long life and I hope Yellen does too, so I would not absolutely bet on that because there are cycles that we have seen over the past decade and I would not exclude that.” Lagarde made it more interesting and shaded more light on the factors that will influence such crash. She added, “Where it will come from, what form it takes, how international and broad-based it will be is to be seen, and typically the crisis never comes from where we expect it.”
Jokes aside, the recovery in the global economy is gaining steam backed by both advanced economies and emerging-market countries due to healthy demand and rising consumer spending. World GDP is expected to grow to 3.5 per cent in 2017 and 3.6 per cent in 2018 compared to 3.1 per cent in 2016 as per IMF’s July forecasts. Emerging market and developing economies is expected to grow to 4.5 per cent this year and 4.8 per cent in 2018 from 4.1 per cent in 2016.
Key to successful asset allocation strategy is to monitor and understand leading indicators (not lagging) such as orders and inventory changes, financial market indicators, business confidence which helps determined better market cycles. By looking at OECD latest report, their composite leading indicators continue to point to stable growth momentum and they do not foresee significant undesirable shift in global economic activities for the short term (six to nine months). Three years back, lots of analysts called a hard landing for the Chinese economy, however its economy appears to be robust and continues to grow at healthy rate of above six per cent.
Valuation wise, it’s not a surprise to anyone, looking at the US, its market valuations seems stretched and above its 20 years medium by 15 per cent, the S&P 500 forward P/E is now trading at 19x as of 7 August 2017. However, we believe if Trump manages to pass the tax reforms and most importantly to convince the Congress to agree smoothly in September on lifting the debt ceiling to the desired level (cap) to implement the infrastructure spending plans, it would, in my opinion, continue the positive momentum and limit major setback. Failing to do so could lead to critical consequences on global economies and the financial markets.
Going into the second half of 2017, we expect the Fed to continue to raise interest rates over the next few years as long as inflation keeps ticking up and no recession occurs. I believe the US will keep all options open when deciding to raise interest rates and will react to any events the economy may face and keep their eyes glued to capital markets volatility.
The North Korea tension is early to judge but it seems that Trump’s strong pressure on China and Russia to use its economic leverage to halt North Korea’s nuclear weapons development is somehow working. The administration managed to pass a UN resolution by all 15 UN Security Council members to pass economic sanctions on North Korea that aim to cut its exports by about a $1 billion a year. This is a big shift in China’s foreign policy and could curb potential conflict that will leave major consequences to the world.
A number of headwinds are facing the UK economy and signs of losing momentum as the impact of Brexit vote started to punch the economy. It is expected that the negotiations with the EU will take a long time which creates more uncertainties with regards to the future of trade, impact on the pound and its effect on inflation and disposable income. There is no disagreement that the financial sector will be impacted drastically; Deutsche Bank is said to move its trading desk from London to Frankfurt which indicates the loss of hundreds of jobs with thousands of clients.
The last few years witnessed a major shift in the Middle East & North Africa (MENA) region changing the face of several countries. A region that was blessed with natural resources from historic places to massive oil reserves supported by a young population has gone into huge turbulence that left few countries on their feet. Prior to the so called Arab Spring, the Gulf region’s sovereign wealth funds had access to more than $2 trillion attributed to high oil prices. Since 2014, oil dropped from its high of $125/barrel (Brent) to as low as $28/barrel, recording a 78 per cent drop in lost revenues for countries that were highly dependent on oil which pushed major fiscal and structural reforms to adapt to the new norm.
The rebound in oil prices to $50 level and political stability in major economies such as Egypt are expected to boost economic growth of the MENA region to 2.9 per cent in 2018 according to World Bank estimates. Countries that are adapting to world changes by riding the technological development wave will have a better chance for a more resilient economy and sustainable diversity. A great example is the UAE where their leadership adapted swiftly to market changes and managed to continue to attract a lion’s share (approximately 50 per cent) of total foreign direct investments into the Gulf region.
The second half of 2017 will witness a rolling back of some of the cheap funds circulating in the market and the shrinking of the Fed’s $4.5 trillion balance sheets which would put a cap on further market rally. For the medium term, downside risk would be limited as policy makers will continue to adapt to a flexible tactic supported by low interest rate environment.
Markets can stay expensive for a long time, but this is what I learned—stay invested.