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Is 2018's rosy economic outlook really that rosy?

The economic outlook for 2018 may look rosy but the wider market already appears positioned for that – and, when this happens, things can often go very differently from how investors were hoping

16/01/2018

Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

As you weighed up your investment options for the year ahead, did you consider putting some of your money to work in Bhutan, say, or Ethiopia?

What about Anguilla or Dominica?

No, we are not being facetious – those are the countries that, according to the Economist Intelligence Unit and along with India, apparently enjoy the best prospects for gross domestic product (GDP) growth in 2018.

Given how little store we set by forecasts, here on The Value Perspective, this does not mean we are now radically altering the geographical make-up of our own investment portfolios – nor are we suggesting you do so.

We are, however, struck up by the hugely optimistic picture being painted by the GDP forecasts for the world’s economy and which looks as follows:

 The fastest-growing and shrinking economies in 2018

Source: Economic Intelligence Unit, taken from economist.com, 5 January 2018. The forecasts included should not be relied upon, are not guaranteed and are provided only as at the date of issue. Forecasts and assumptions may be affected by external economic or other factors

 

As you can see, only North Korea and a few other countries equally unlikely to be featuring among Donald Trump’s holiday plans are expected to see a fall in their GDP numbers in 2018.

In contrast, some three-quarters of the countries are expected to see their GDP grow in excess of 2% this year, with the forecast GDP growth for the world as a whole working out at a pretty robust 2.7%.

We ended last year noting 2017 had been an extraordinary year for markets – and, to judge by the above chart, 2018 is shaping up to follow suit.

Really – what could possibly go wrong?

Well, in the spirit of fairness and balance, on the other side of the ledger can be found a number of statistics that may perhaps give investors pause for thought.

Pause for thought 

Take, for instance, the asset allocation survey from the American Association of Individual Investors, the December version of which showed equity allocations at 72%.The last time they were higher (at 74%) was in July 2000.

For their part, cash allocations were at 13%, with the last time they were lower (at 12%) being December 1999.

The resulting ratio of equity to cash allocations of 5.5x was also the highest since 1999.

This impression investors are now going ‘all-in’ on the equity front is only strengthened by other data – for example, the news that cash as a percentage of assets among Charles Schwab clients has fallen to 11%, its lowest level for more than 20 years, and that US equity gross long/short hedged exposure is back above 190%, which is its highest level since March 2007.

Market is positioned optimistically

So, yes, the economic outlook may be rosy but the wider market does already appear to be positioned for that – and not for any other less optimistic eventuality.

Generally when this happens – and you will be well aware of the most recent instances of 2000 and 2008 – things can go very wrong indeed. And, as we wrote in So farewell then, 2017, after such an extraordinary year, it seems unlikely markets will now go flat.

“If strong economic data continues to come through, it is easy to imagine markets continuing the strong performance seen during 2017,” we noted.

“Equally, if the data were to stumble even a little, it would be easy to imagine markets significantly lower.”

Investors might even get to enjoy a little more ‘smooth’ before any ‘rough’ really hits. Time will tell – but a bit more caution than we are currently seeing would not be amiss.

Author

Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

I joined Schroders in 2000 as an equity analyst with a focus on construction and building materials.  In 2006, Nick Kirrage and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Nick and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.

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