Global economic growth and benign inflation provided an extremely supportive environment for risk assets in 2017. As the year progressed, deregulation and anticipation of tax reform in the U.S. brightened investor sentiment even more. Although the Federal Reserve continued to raise short-term interest rates, its gradual course and the accommodative policies of other global central banks helped keep long-term rates in check, resulting in a flattening of the yield curve.
Our current positioning reflects the following beliefs:
- Many of 2017’s positive economic tailwinds should continue in 2018, setting the stage for additional upside in stocks and other equity-sensitive assets, including convertible securities and high yield bonds.
- Global economic expansion is on track, and the risk of recession in the U.S. and other major economies is low.
- Volatility will begin a slow return to its longer-term trend, but this is likely to be gradual so long as central bank accommodation remains intact. We may also see significant shifts in leadership in this maturing bull market.
- In a rotational and more volatile environment, the benefits of active, risk-aware management will be pronounced.
- Investors should not be surprised if the stock market experiences a modest downturn in 2018 before resuming its advance. In fact, the absence of recent corrections has been remarkable (Figure 2).
- As 2018 progresses, there may be a slight pick-up in inflation, but the expansion narrative should remain intact. Central banks are likely to become less accommodative as the year progresses, but we expect monetary policy to evolve in a gradual and deliberate manner.
- The most significant potential risks in the current environment include an unexpectedly rapid rise in inflation, significant shifts in central bank policies, and a boiling over of geopolitical conflicts (e.g., North Korea). U.S. mid-term elections may also stoke volatility, as could elections in Italy, Mexico and Brazil.