Global economic data continues to impress, US consumer confidence has hit new highs, China’s economy has stabilized, and the country is focusing on upgrading its economy. The positive economic data sets the stage for 2018.
In this article, I will detail the factors underpinning the world’s synchronized growth, and why the global portfolio overweight equities and underweight bonds going into 2018.
Impressive global economic data
Recent US activity data has been better than expected. US GDP growth in the third quarter beat expectations at 3.0 percent, with trade and inventories together contributing over 1.0 percent to growth. US consumer confidence is near a 17-year high. The buoyant US labor market and prospect of tax cuts next year should support consumer demand in the near term, though we have reservations over long-term demand in view of the low household savings rate.
For China, the official Purchasing Manager Indexes (PMI) for manufacturing and services both eased back in October, though the SME and export-oriented Caixin manufacturing PMI held up better. That said, with business confidence high and demand and price indicators holding up, we feel the growth momentum is unlikely to fall sharply in the fourth quarter.
The Chinese property sector is expected to weaken and act as a drag on growth, but the new policy initiatives unveiled at the party congress last month should be sufficient to support growth of 6 percent plus in 2018.
While the macro data has clearly been positive, it remains our view that buoyant survey readings are probably running “rich” relative to reality. A good macro outlook for 2018 need not necessarily mean strong market returns as in 2017, though a favorable economic backdrop certainly helps.
We think equity valuations are unlikely to mean-revert unless bond yields rise sharply. But with global inflation subdued and monetary accommodation being withdrawn only gradually, yields are expected to remain well behaved in 2018. Our global portfolios remain overweight equities and underweight bonds.
Within equities, we prefer the United States, Japan and Asia over Europe, the United Kingdom and emerging markets outside Asia. Within fixed income, we are quite cautious in the short term after the recent selloff in high yields and appreciation of the trade-weighted dollar. We expect that the quest for yield will still be there as a theme for fixed-income investors in 2018.
China after Trump visit and the CPC Congress
China and the US signed trade deals totaling US$253 billion (for comparison, the entire 2016 bilateral trade deficit with China was US$254 billion), covering everything from agriculture and auto parts to energy. The deals are mostly with large Chinese state-owned enterprises (SOE), so Beijing will be better positioned to follow through.
On 10 November 2017, the day after US President Donald Trump’s visit, China’s Vice Finance Minister Zhu Guangyao announced a major financial reform – the opening of China’s domestic financial markets to foreign banks, brokerage houses and insurance companies.
At the 19th National Congress of the Communist Party in Beijing in mid-October, President Xi Jinping consolidated his grip on power, becoming only the third leader after Mao Zedong and Deng Xiaoping to have his political “Thought” enshrined in the Chinese Constitution.
Under Xi’s leadership, China is likely to play a more active role in world affairs. This could benefit the west through increased cooperation, but could pose challenges if China’s interests are to be accommodated.
We expect to see further efforts to improve the performance of China’s SOEs. This will include a greater role for public-private partnership. SOE managers can learn from China’s successful private sector entrepreneurs under this partnership.
Other key economic themes include cleaning up the environment (“Beautiful China”), reducing excess capacity in heavy industries (supply-side reform), and financial de-leveraging (macro prudential framework). There will be more focus on the sustainability and quality of growth, with a strong commitment to eradicating poverty and reducing income inequality.
President Xi also announced at the CPC congress that China should become a world leader in innovation by 2035. China’s “New Economy” – IT, the internet of things, electric vehicles, green energy, etc. – can expect to receive strong government support. Beijing regards new industries like electric vehicles as a chance to “leapfrog” as opposed to merely “catch up” with western technology. R&D spending is growing rapidly in China, as is tertiary education in science, mathematics, computing and technology.
US tax reform
There appears to be a reasonable chance of some kind of tax reform package being approved by the US Congress. There are significant differences between the House and Senate tax bills and tough negotiations lie ahead. Agreement on a reconciliation bill is likely to be delayed until the first quarter of 2018. The basic features have not changed much from President Trump’s original plan.
All that said, to focus on the macro or GDP impact of the US tax package is to largely miss the point. It is the microeconomic effects that matter most. The majority of US firms stand to benefit from lower corporate tax rates. Banks are one of the highest tax-paying industries in the US and the sector stands to benefit significantly.
A second potential benefit for many firms is the current expensing of investment spending. This is likely to trigger an increase in investment in capital projects and hence loan growth and demand, which will also be beneficial to banks. Other sectors with high effective tax rates include consumer staples, consumer discretionary, utilities and industrials.
To sum up, there is still considerable uncertainty as to whether the US Congress can agree on tax reform in the first quarter of 2018 and as such it is not priced into markets. But if it does go ahead, the tax cuts would give a strong boost not just to the S&P 500 (potentially a 7 percent addition to EPS in 2018), but also to business confidence and stock markets globally.
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