Adrien Pichoud Economist
Maurice Harari Multi Asset Portfolio Manager
Wanda Mottu Analyst
Christophe Buttigieg Junior Analyst
01

Global economy - Positive momentum in 2017, to be extended in 2018

Looking back at 2017, one of the main features was the global economy emerging from a three year slump during which Eurozone weakness, China’s slowdown and the oil price’s collapse had all helped dampen growth momentum. This soft patch came to an end last year and left room for a remarkable year of synchronised global expansion.
Of course, this improvement has long been trailed by prevailing supportive monetary policies across developed economies. The recovery in US business investment after the energy-related slump and the maturing of the Eurozone recovery into a full-blown expansion have supported the underlying improvement in the economic backdrop.
Interestingly, this dynamic is set to extend into at least the first half of 2018: manufacturing indicators are heading up across the board, reflecting ongoing positive momentum as tax cuts are finally being implemented in the US, oil prices continue to rise and Continental Europe remains in a virtuous growth cycle.

Global growth has recovered positive momentum in 2017

Sources : Factset, SYZ Asset Management. Data as at : 31 December 2017

Global growth has recovered positive momentum in 2017

Rising short-term rates, declining balance sheet; it’s normalisation time!

Sources : Bloomberg, Fed, SYZ Asset Management. Data as at : 31 December 2017

Rising short-term rates, declining balance sheet; it’s normalisation time!
02

US - Monetary policy normalisation becomes real

Previous Federal Reserve Chairman Ben Bernanke had opened the debate around Fed policy normalisation during the spring of 2013, at a time when QE was running at full speed and the Fed Fund rate was at its floor. Successor Janet Yellen, whose mandate will expire in February this year, will hand over to Jerome Powell a Fed firmly engaged in normalisation.
Indeed, in 2017, the Fed raised its key Fed Fund rate three times to 1.5%. This has made it the most advanced developed central bank on the path of reversing unorthodox post-crisis monetary policies, while the European Central Bank (ECB) and the Bank of Japan (BoJ) are still running asset purchase programs and negative short-term rates.
The Fed has even launched the unwinding of its USD 4.5 trillion balance sheet, by gradually slowing down the pace of coupon and maturing bonds reinvestment. There is no reason for the normalisation dynamic of 2017 to not extend into 2018.

03

Eurozone - From recovery to broadbased expansion

Amid the broad favourable economic backdrop of 2017, Europe has certainly stood out - not only as the economic area with the most dynamic momentum and strongest growth relative to its potential, but also as the area delivering consistently better economic performances than expected by the consensus.
As a result, the monetary union has recorded its strongest annual GDP growth in a decade. Its powerhouse, Germany, accounts for a large share of this acceleration as it is enjoying perhaps its best economic period since reunification. But, all European economies have posted significant economic improvement, even if admitedly sometimes from weak starting points: even Greece has resumed a positive GDP trend, and Italy and France, laggards to Germany and Spain in 2016, have also improved their growth figures.
Such synchronised and strong growth marks 2017 as the year when the Eurozone will have moved from recovery to an expansion phase of the cycle.

Synchronised positive growth dynamics among Eurozone members

Sources : Factset, SYZ Asset Management. Data as at : 31 December 2017

Synchronised positive growth dynamics among Eurozone members

The UK economy has digested the immediate post-referendum shock

Sources : Factset, SYZ Asset Management. Data as at : 31 December 2017

The UK economy has digested the immediate post-referendum shock
04

United Kingdom - The economy withstands the post-Brexit referendum so far

2017 has been dominated in the UK by political convolutions around Brexit negotiations with the EU, from a failed attempt by Theresa May to strengthen her parliamentary majority to a December cliffhanger drama that finally ended with an agreement on the divorce’s terms, opening the door to discussions on the future relationship.
From an economic point of view, however, 2017 has seen the UK digesting the post-Brexit referendum shock. Activity indices have quickly bounced up from their summer trough, to levels in line with close-to-2% GDP growth. Slower growth than pre-Brexit for sure, but not quite the recession feared by many.
Inflation has jumped toward 3%, weighing on consumption, but manufacturing activity has held up, supported by GBP weakness and buoyant global demand. The Bank of England has since reversed its post-referendum emergency rate cut. Until more clarity on the future of the UK-EU relationship is given, the British economy is set to remain in these economic mid-waters.

05

Japan - The sun keeps shining on the Land of the Rising Sun

The Land of the Rising Sun has quietly experienced another year of growth in 2017, extending its longest business cycle without a recession for a decade. GDP has expanded at more than twice the potential rate of the economy, helped by positive dynamics at the external and domestic level.
Indeed, the unemployment rate is at its lowest level since the early 90s, nominal wages have been constantly growing in the past three years (even if at a slow pace) and consumer confidence is at a decade-high. This supports domestic demand and consumption as a contributor to economic expansion.
In the meantime, global growth has supported exports and brought the trade balance back into surplus in 2016 and 2017, after an unprecedented five-year period of deficit. Therefore, the improving economic backdrop is this time shared by most of the Japanese economy. The level of Tankan indices gauging business conditions is illustrative of such a broad based bounce: they are at their highest levels in a quarter of a century.

Business confidence runs high across all sectors and corporation sizes

Sources : Factset, SYZ Asset Management. Data as at : 31 December 2017

Business confidence runs high across all sectors and corporation sizes

Economic activity stabilises but long-term rates rise on leverage crackdown

Sources : Factset, SYZ Asset Management. Data as at : 31 December 2017

Economic activity stabilises but long-term rates rise on leverage crackdown
06

China - A welcome respite in 2017, before wobbles in 2018 ?

In 2017, something peculiar happened or rather did not happen in macro discussions: China was barely a source of concern, reversing the pattern of the previous few years. Indeed, GDP data, for what they are worth, were astonishingly stable, recording just below a 7% real growth rate, allowing President Xi to open the Party Congress in October with the claim that economic objectives had been fulfilled.
Other data series (PMI manufacturing & services, industrial production) have also been pointing to a stabilisation of growth after six years of slowdown. The yuan has even appreciated against the USD in 2017!
Does this mean that all is well in the world’s second largest economy? Not quite, as the large and growing indebtedness level continues to threaten macroeconomic stability in the medium term. So much so that, right after the Party Congress, new measures aimed at cooling down leverage and credit growth have been announced, prompting a temporary selloff in Chinese equity markets and pushing government 10-year interest rates toward 4%. Given its size and importance in the global trade and financial system, China cannot remain away from the headlines for long.

07

Fixed Income - US Government two-year yield above S&P 500 dividend yield

In 2017, short-term interest rates were under pressure on the back of further monetary policy tightening by the Fed. The difference between short-dated and longer-dated US Treasury yields has narrowed at its fastest pace post-Lehman crisis, as market participants bet on a quicker rate of policy normalisation going forward.
Looking back at the US Government 2 year treasury yield, it has gone from 1.19% (at the beginning of 2017) to 1.88% at the end of December (a rise of 69 bps), while the longer end of the curve continued to edge lower. Actually, last year was characterised by a bear flattening of the US yield curve, i.e. short-term interest rates rising faster than long-term interest rates.
Moreover at the end of December, the US Government 2 year was yielding slightly more than the US equity market (represented by the S&P 500 dividend yield) for the first time since late 2008.

US Government 2 Year yield surpassing S&P 500 dividend yield

Sources : Bloomberg, SYZ Asset Management. Data as at : 31 December 2017

US Government 2 Year yield surpassing S&P 500 dividend yield

Russell 2000 Net Debt and EBITDA

Sources : Bloomberg, SYZ Asset Management. Data as at : 31 December 2017

Russell 2000 Net Debt and EBITDA
08

Equities - US small caps debt rising at a much faster pace than earnings

Until 2008, the net debt of US small caps (Russell 2000 index) was rising at a sustainable pace compared to earnings (EBITDA), before sharply decreasing in parallel with EBITDA at the start of the great financial crisis until the first part of 2010. Since then, we have seen a growing divergence in the path of these two financial indicators; on one hand, net debt has seen a staggering expansion and on the other hand, EBITDA only continued to edge higher as in past years.
Moreover, the deal on corporate tax reform could be positive for smaller companies, as they normally have a higher local foot print than large caps. But it seems that in terms of market performance, the reform is already priced in since the Russell 2000 has recently outperformed large caps.
Finally, tighter monetary conditions going forward in the US but also in other developed economies are putting small caps in a more vulnerable position, given their higher leverage ratio compared to S&P 500 companies.

09

Eurozone - The market is pricing in the QE tapering

In October 2017, the European Central Bank has finally announced plans to scale back its expanded asset purchase programme, initiated in March 2015. The ECB policy members felt confident about the gradual convergence of inflation towards the central bank target and decided to halve the monthly bond purchase to 30 billion euros as of January 2018. At the same time, they announced the extension of the bank’s quantitative easing program until at least September 2018 and the continuation of the reinvestment of coupon and maturing debt after the end of the programme.
The market has started to price this reduction in QE, notably by the increase of short-term German rates at year-end. Despite ending 2017 in negative territory at -0.6%, the two-year bund yield has globally increased over the year. There was no such a dynamic on rates since 2013, as over the last three years the German short-term yield has been consistently edging lower.

The German two-year yield ended 2017 higher

Sources : Bloomberg, SYZ Asset Management. Data as at : 31 December 2017

The German two-year yield ended 2017 higher

Evolution of the market capitalisation of cryptocurrencies (in billion USD) over 2017

Sources : Cryptocompare, SYZ Asset Management. Data as at : 31 December 2017

Evolution of the market capitalisation of cryptocurrencies (in billion USD) over 2017
10

2017 : The year of cryptocurrencies !

Cryptocurrencies were certainly the hot topic of 2017, with prices reaching stellar levels. Bitcoin, which started the year below $1’000, touched $20’000 in December in a kind of euphoric market, when exchanges were onboarding more than a million new users a day.
But Bitcoin was not the only currency under the spotlight. Hundreds of new cryptocurrencies emerged last year, while existing ones got more attention from investors as illustrated by their escalating market capitalisation. When considering four of the major players (Bitcoin, Ethereum, Ripple and Litecoin), their combined capitalisation grew from $16.6bn in January to $378bn at the end of December, with Ripple becoming for a moment the second major currency ahead Ethereum.
Obviously cryptos are likely to remain volatile going into 2018, but investors should monitor this space closely. The underlying blockchain technology has a promising foundation in multiple sectors and a number of large players such as JP Morgan, UBS or Banco Santander are making significant investments in this field.

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