Investment fundamentals good for 2018 — but beware the ‘FANGs’

Financial markets enter 2018 against a generally benign background of rising asset valuations, accelerating economic growth, and rebounding levels of world trade. But the potential for non-economic or financial factors to upset this global “goldilocks” scenario has never been greater.
Equity markets enjoyed a record year in 2017, with all the major indices in high-teens or low-20s percentage growth patterns; real estate was on an upward trajectory globally; commodities like oil and metals enjoyed a recovery.
In terms of economic growth, for once the world experienced a more-or-less coordinated recovery. When the US, Europe and China all move upward together — even at different rates — it can only be good. Trade levels, as measured by the shipping indices, hit a four-year high.
Stability in financial markets was also at an all-time high. Despite the ongoing unpredictability of politics in the US, Brexit-wary Europe, the Middle East and some parts of Asia, the VIX index — which measures the markets’ perceptions of volatility — was at its lowest in the three decades since it was devised.
There are some near-certainties about the coming year, but they are not all reassuring. One is that central banks in the US and Europe will finally begin to ween their economies off the drug of quantitative easing (QE) that they have grown dependent on since the global financial crisis in 2009.
QE — which principally involves the buying of bonds by the state financial authorities — has been a such a permanent feature of financial life for the past decade that its removal will have to be managed very carefully to avoid a collapse in financial asset prices.
This is especially true in the technology sector, where valuations are at stratospheric levels. Some experts are beginning to talk about the “fear of FANGs” — meaning the risk of investing further into the tech market-leaders Facebook, Apple, Netflix and Google. Given the fact that these companies are now among the biggest in the world and a major component of equity indices, it is a justified fear.
The flip side to the ending of QE is likely to be rising interest rates, with the US Federal Reserve setting the global tone as ever. Some experts predict four rate rises by the Fed this year, sucking out of equity markets the liquidity that has fueled the long bull run.
In the world’s biggest market, the US, this loss of liquidity, in theory, will be replaced by the stimulus of President Donald Trump’s tax cuts, but that involves a calculation that the foregone tax will be spent on investment and jobs, rather than bumper dividends, extravagant takeovers and executive bonuses. No such calculation is possible in Trump’s America.
It is the sheer unpredictability of the US that could dash the benign economic and financial outlook. What effect on markets will there be from mid-term elections, continuing FBI investigations and (possible) impeachment proceedings? It is almost impossible to say, but it’s a safe prediction that the VIX index will be more active in 2018. North Korea alone could cause a sharp spike in volatility and a corresponding drop in markets.
Against this uncertainty, the emerging market (EM) outlook looks boringly stable. China, the great driver of the Asian hemisphere (although India is increasingly doing its bit) looks set to enjoy gross domestic product (GDP) growth approaching 7 percent. This also drives world trade from the great Chinese manufacturing centers.
The big threat to all this comes — again — from the US. The Trump presidency has declared time and again that it sees China as a dumper of manufactured products and a manipulator of currencies, and is inching toward some kind of tariffs against the world’s biggest exporter. A full-blown trade war could knock aside all those forecasts of healthy global growth.
None of this would be good for the Middle East, as a great trading crossroads and the major global supplier of energy. Saudi Arabia looks set to join the EM club next summer when it will (probably) enter the MSCI indices, so any hit to EM valuations will affect the Kingdom more than ever, just as it is beginning to spend its way out of the “austerity” polices of the past three years.
For the Middle East, the economic outlook is better for 2018 than it has been for some years. Rising oil prices and trade levels add up to substantial rises in GDP growth for most countries in the region.
But again, uncertainty and volatility are the main threats. Conflict and confrontation in Iran, Qatar and Yemen, with seemingly permanent tensions in Iraq, Syria and Palestine, could all explode into market-damaging chaos. The region almost deserves a VIX index of it own.
On New Year’s Day, the fundamentals look good. But there is also much that could go wrong in global financial markets. Proceed with caution in 2018.