15 Dec 2017 5 min read

Are we approaching a market peak?

By Emiel van den Heiligenberg

With the equity rally looking set to complete a ninth year – the investment question on everyone’s mind is simple: can it continue


Emiel: Do you think 2018 could mark the end of this bull market?

Lars: No, in fact I think there’s still a case to be made that 2018 will be the year this bull market becomes the longest of all time. Although topping a vintage 2017 will be difficult, the possibility of corporate tax cuts without more wage inflation could result in a repeat performance.

We’re seeing the greatest opportunities in European equities, where earnings growth should benefit from the strong global economy and lower starting margins, while valuations are less ambitious.

"We’re seeing the greatest opportunities in European equities, where earnings growth should benefit from the strong global economy"

Tim D:
 I would argue for caution as the current combination of low inflation and strong growth in the US is unlikely to be sustainable. We see increasing recruitment difficulties and rising capacity utilisation as evidence of diminishing slack. Unless growth slows, core inflation is likely to move gradually higher. Business and consumer confidence has remained high and despite the delay to Trump’s tax agenda, it seems likely that Congress will deliver a stimulus worth close to 1% of GDP in 2018. With the economy already at full employment this fiscal boost risks overheating the economy.

Emiel: Our call on the economic cycle becomes even more important in the next 18 months. Equities have done really well in recent years because the economy has been mid cycle. The more bottlenecks and inflation pressures emerge the higher the chance of a recession and that is the worst period for equities. I draw some comfort that Tim doesn’t see a recession in 2018 but we need to be careful as we are inching closer, especially as this environment limits the visibility on what would be the catalyst for a large asset price correction.

Emiel: What are the chances that China starts to slow down significantly?

Erik: This is not our base case. We forecast growth in China will slow in a measured way from 6.8% in 2017 to c.6.5% in 2018, as the authorities attempt to control financial excesses, limit the rise of property prices and environmental degradation. The government has sufficient fiscal space to smooth this adjustment process, but timing the cycle is not trivial as evidenced by previous swings in activity over the last year.

Emiel: Is there anything we’ve missed?

Lars: I think it would be wise to keep a close eye on the technology sector, with it having led global equities higher this year and given its increased weight in equity indices. It’s also at the heart of many macro debates: Can automation keep a lid on wage pressures? Will technological progress show up in productivity data and extend the economic cycle? Could a regulatory backlash against Silicon Valley dent the performance of tech stocks?

Emiel: I agree, along with energy, demographics and the newly added politics theme, technology is one of LGIM’s long-term themes and one with clear macro consequences.

Thanks all for the discussion. Equities have done really well in the last couple of years thanks to a synchronised economic recovery, but only subdued inflation. This is consistent with mid-economic cycle dynamics. Our economists do not see a recession in 2018, but we need to stay vigilant as we are clearly inching closer. I think this is an important time to draw a distinction between one’s forecast of where markets are likely to go and the appropriate investment strategy.

I agree with my colleagues (Lars and Chris) that conditions driving the impressive equity bull market could stay in place for much of 2018 and that rates will stay low for some time. However, I see potential sources of downside risk in 2018 as well given low current volatility, tightening labour markets, Fed rate hikes and the tightening of QE measures across the globe, combined with the longstanding views on structural headwinds for growth like debt and demographics. We start the year with a tactically cautious view on equities. Predicting the timing of any pullbacks is tough, but timing is crucial for our clients’ outcomes as market returns may stay strong until just before a correction. Therefore, as macro investors, we spend a lot of resources on analysing market risks and mapping them into our asset allocation.

Moreover, we need to factor in that we could see a recession somewhere in 2019. As most bear markets are associated with recessions, and with the stock market typically leading the economy by 6 to 12 months in advance, we cannot rule out late cycle dynamics and potential sources of downside risk in 2018. These sources include policy changes and political challenges as highlighted in our previous posts in this series.

"This is an important time to draw a distinction between one’s forecast of where markets are likely to go and the appropriate investment strategy"

In this light I believe investors should to stay prudent in their investment strategy. You can do this in three ways. The most active way is to stay long equities but keep the finger on the trigger to reduce risk when we see more late cycle signals. A more systemic way is to gradually lower the equity exposure as we go deeper into 2018, and finally you could add hedges to the portfolio. As mentioned earlier, we believe that portfolios that are long market risk should consider being long inflation and long the US dollar and Japanese yen.

On a lighter, related note, we’ll be enjoying the party while it lasts.

For a more detailed read of our 2018 outlook, see our latest Market Insights piece Walking the tightrope.

You can also click attend below for our live webinar, which will be hosted by Tim, Chris and me. If you have any specific questions we encourage you to email them to MacroMatters@lgim.com.

Macro alias: ScriptInsert

We encourage you to post any questions below in the comments section and we will try to address them during the webinar.

Emiel van den Heiligenberg

Head of Asset Allocation

Emiel is responsible for the overall strategic direction of the team’s investment and business strategy. He claims to have been a promising lightweight rower at university until French fries got the better of him. Reflecting his love for rowing in a team, he firmly believes that excellence can only be achieved by a great team made up of motivated individuals that are also eager to work together. To this end he is the self-proclaimed inventor of the verb 'teaming' to acknowledge that shaping a top team and culture of excellence is an ongoing process. Outside of work-family obligations, Emiel’s spare time is filled by a passion for shark diving and skiing. Prior to dedicating his career to portfolio management in 1996, Emiel worked as a policy adviser in the Dutch Ministry of Finance and he graduated from Tilburg University in the Netherlands ages ago. When not glued to his Bloomberg screens, this Dutch man is hooked on computer games, peanut butter and his favourite dark beer made by Belgian monks.

Emiel van den Heiligenberg