Although we believe for the next 12 to 18 months that activity will remain at, or above, trend in the majority of the large economies, growth will be less synchronised than previously for a number of reasons:
• The impact of the US fiscal stimulus will primarily benefit the country’s domestic economy, while forcing the Federal Reserve into a faster pace of policy adjustment and generating negative spill-over effects for foreign economies through tighter dollar liquidity conditions;
• The large increase in oil prices is redistributing income and activity away from oil-importing economies to oil producers, and from consumption to investment;
• The less accommodative stance of Chinese policy will lead to a further moderation in domestic activity while weighing on activity in those developed and emerging economies most affected by the Chinese cycle;
• The natural slowdown in the eurozone and Japanese economies from their unsustainably rapid growth last year.
The positive backdrop, accompanied by only a modest increase in core inflation, should deliver high single-digit global corporate profit growth in 2018 and at least the first half of 2019.
Pressures on company margins are appearing in a few US sectors – transport is an example – but are generally expected to be manageable. This reflects the benefits of tax cuts and stronger productivity growth from business investment, as well as the lack of wage pressures in other economies.
Although tariffs and policy measures put in place so far have been modest from a macroeconomic perspective, they undermine the rules-based global trade system and raise uncertainty about the future. This has the potential to undermine the upswing in global business investment and lead investors to demand a higher premium to hold risk assets.
A second issue to consider is the interaction of fiscal and monetary policy.
Although the global monetary policy cycle is expected to turn only slowly outside the US, restrained by muted inflation pressures, the late-cycle US fiscal stimulus increases the risk of overheating, and hence raises the medium-term risks to global economic expansion.
Indeed, even if these risks do not materialise, there remains a chance that less-confident investors choose to discount them from time to time, leading to questions around other potential sources of economic and equity market vulnerability.
A good example is emerging markets, where the recent appreciation of the dollar has led to a reversal in capital flows.
Growth expectations
Given the cyclical backdrop, our valuation framework shows a normal relationship between equities and bonds, with similar findings for credit spreads and the dollar.
Equities have de-rated enough to price in the likely more moderate growth this year, and may have overshot on the downside.
Credit spreads are wider, consistent with a general slowing in growth expectations, and notably this does not appear to be emerging market-specific.
Dollar strength is not independent of the previous two observations: the currency appears to be largely driven by growth divergence rather than bond spreads, and is behaving normally.
The fact that emerging market currencies are moving pretty much in sync with the trade-weighted US dollar, suggests this is part of the global growth repricing rather than anything more.
The risk of trade wars has been discounted to some extent, as evidenced by the performance of equity markets and sectors.
While US President Donald Trump is unlikely to ease the pressure on trading partners prior to the mid-term elections, some moderation in rhetoric is possible thereafter should common sense prevail, which would allow investors to refocus their attention on supportive equity market fundamentals.
Andrew Milligan is head of global strategy at Aberdeen Standard Investments
