Citi experts remain optimistic on global economic outlook for 2018

12th January 2018
Resources Rising Stars

Risks are rising but it’s too early to call the end of the bull market in equities, reports The Australian.

After a serious think about what could upset the “Goldilocks” scenario of unprecedented central bank stimulus, positive economic growth and low inflation that’s boosted stocks and commodities for the past two years, Citi’s top minds say investors should stay overweight stocks and commodities while going neutral bonds and underweight corporate credit.

The team predicts a decent 8 per cent rise in the global sharemarket. That’s underpinned by their expectation of a 12 per cent rise in earnings per share amid synchronised economic growth, but the biggest gains are expected in emerging markets and Europe.

Australia’s share index gets an underweight rating only because it’s expected to lag strong gains elsewhere. The S&P/ASX 200 share index is expected to end the year around 6400 points, implying a 5.5 per cent capital gain plus dividends.

In terms of global sectors, Citi has overweight ratings on materials, financials and IT, neutral ratings on energy, industrials, telcos and consumer discretionary stocks, and underweight ratings on consumer staples, utilities and healthcare stocks.

Despite a number of warning signs — including the start of ­“euphoria” in Citi’s Panic-Euphoria Model for the flagship US market and the strongest global earnings revision ratio since 2000 — the US investment bank’s “bear market checklist” scores only 3.5 out of 18 possible “red flags”.

No doubt the start of the year has so far been a cracker for equities.

The ASX 200 is up 1.6 per cent year-to-date after hitting a fresh decade high of 6150.

More importantly, the benchmark US market has risen by 2.8 per cent in the past five days.

Notwithstanding the potential for profit-taking after the US tax reforms — particularly since US investors can now pay lower short-term capital gains tax on their winners and push any related liability out to April next year — there’s some pretty strong backing for the “January effect” or at least the ability of the sharemarket’s performance in early January to predict the course of the year.

The S&P 500 has risen more than 2 per cent in the first five days of the year on 15 occasions since 1950 and it has gone on to a full-year gain every time, with an average gain of 18.6 per cent, according to LPL Financial senior market strategist Ryan Detrick.

To be sure, central banks are expected to hike interest rates and taper their bond buying that’s pushed an unprecedented amount of liquidity into markets since the financial crisis.

And Citi analysts say their pro-cyclical strategy is vulnerable to a potential “disorderly sell-off” in credit markets, a “marked China slowdown” and any unexpected political shocks.

The Italian election in March is seen as a potential flashpoint, given that market complacency is high.

But ongoing strength in the global economy should drive another year of synchronised EPS growth, with all regions expected to record gains, with a 12 per cent increase in corporate earnings expected to provide a continued tailwind for global equities over the next 12 months.

Still, higher short-term interest rates and withdrawal of quantitative easing are likely to put upward pressure on government bond yields and credit spreads, providing a “headwind” for global equities over the next 12 months, with higher credit spreads usually associated with rising equity volatility.

“Global equity returns in 2018 will be defined by the trade-off between these two powerful forces,” says Citi’s chief global equity strategist Robert Buckland.

“We think that higher EPS should eventually win out, but rising volatility means that the journey will not be as smooth as in 2017.”

Indeed he cautions that equities may enter the “final stage” of the bull market this year.

“This is the final stage of an equity bull market, when equity prices keep rising even as credit markets fade,” he says. “It is characterised by higher volatility, stockmarket bubbles and widening performance dispersion. Growth strategies, especially IT stocks, are the likely overshoot candidates.”

Buckland says the biggest risk for equity markets this year is central bank tapering as lower asset purchases by the central banks will tend to cause higher credit spreads.

“Any turn in the credit markets could prove tricky for global equities,” Buckland says.

“We are also concerned about the impact of monetary tightening on the Chinese economy, given substantial credit expansion over recent years.

“Rising global political risks have not yet proven a drag on markets, but that could change. Watch out for the Italian election in March.”

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