A continuation of low volatility, relatively low interest rates and incremental equity growth is the base case scenario for 2018, according to Daniel Murray, head of research at EFG Asset Management. Murray advises both the asset and wealth management divisions of the firm.
“The reason is that momentum usually requires a big shift, a catalyst or a shock to see it reverse. Very often this comes from the central bank.”
Rising interest rates can result in a contraction in economy activity and hit corporate earnings, he explained, but that is not the base case scenario.
“Next year we know the Fed is tightening, but at a glacial pace. Tightening is inflation-biased. The US Fed has a 2% inflation target and we’re not there yet. It’s about 1.5% at core levels. We can’t see the Fed imparting such a large tightening bias that it brings about a meaningful deterioration in the market.
Borrowing costs, debt servicing costs, remain low. [A market shock] would require a much more aggressive increase in borrowing costs.”
He said it will happen at some point, but as long as fundamentals remain robust, the chances of a market shock are reduced.
Equities plug along
Murray is advising no major allocation changes for 2018. Last year, the firm was overweight US, Japan and emerging market equities and underweight Europe, which he said worked out well.
The firm still favours Japan equities and is maintaining an overweight, he said.
“Typically, the Japan market follows a pattern. It jumps higher in a short space of time, then range trades, then jumps higher, then range trades. You have to hold it and be patient. Timing it is difficult, so we are patient with Japan investments.
“The country is doing the right things. There is an increase in corporate profitability, share buyback activity, structural change in the labour market. You don’t see these changes so much in the headline data.”
In China, the rally this year in equities has been narrowly focused, he said. “There’s room for more upside. There’s an opportunity to broaden out.
“The H and A share play is more interesting with the Stock Connect pipes opened. Regardless of valuation, the discrepancy favours H shares.
“A massive pool of savings onshore is trying to find a home offshore and the Stock Connect represents one way offshore. In it helps local investors diversify their exposure.”
China’s structural change is also going in a positive direction, he believes.
“A centrally-controlled economy can also be a blessing because the government can get stuff done. Authorities ensure average earnings are growing and people generally feel an improving life.”
The key 2018 risk is that inflation may spike higher.
“We might see China exporting a bit of inflation, but it is not a massive risk. There is a risk of some China debt accident, but we expect it to be contained in China. Authorities have such a strong reign on domestic debt and they allow some companies to go bust. Overall, we expect them to prevent a wide scale financial crisis in China.”
