Adrien Pichoud Economist
Maurice Harari Senior Multi Asset Portfolio Manager
Wanda Mottu Portfolio Manager
01

Global economy – Don’t expect much more improvement for 2018

2017 has been the best year for the global economy since the 2008/09 recession. The combination of synchronized economic expansion across the  globe, rising oil and commodity prices and low interest rates has helped spur business cycle momentum: world trade and world industrial production growth have finally woken up from lethargy.

Looking at the outlook for 2018, however, it seems difficult to expect much additional improvement. While the conditions for continuing economic growth are likely to remain in place (European growth catching up, a domestic-driven extension of the US cycle, Japan’s re-emergence, China’s rebalancing), the potential for acceleration is limited. All of these economies are already running above potential growth and the support from monetary policy is likely to be (very) gradually removed. Maintaining a 2017-like growth rate in 2018 would already be a positive achievement in such a context.

Global growth momentum has likely peaked in 2017

Sources: Factset, SYZ Asset Management. Data as at: 8 December 2017

Global growth momentum has likely peaked in 2017

Dynamic US business investment spending to support growth in 2018

Sources: Factset, SYZ Asset Management. Data as at: 8 December 2017

Dynamic US business investment spending to support growth in 2018
02

United States – Dynamic business investment supports the growth outlook

In 2017, oil prices ceased to be a headwind for US economic growth. The stabilisation of crude prices around USD 50/bbl allowed the energy sector to recover after the shock of 2015. The 60% fall in prices and 20% drop in US production in 2015 had prompted a contraction in business investment spending, the first in 50 years not linked to a recession of the entire economy. Nonetheless, resilient consumer spending kept US GDP growth in positive territory, fuelled by falling unemployment and strong consumer credit growth.

The picture at the end of 2017 is almost the opposite: business investment has picked up and firm capital goods orders in early Q4 suggest this dynamic should persist, possibly supported by long-overdue tax reforms. As such, business spending might become the main driver of US growth next year, at a time when consumption is losing steam amid slowing consumer credit expansion and subdued real disposable income growth.

03

Eurozone – On track for the strongest annual growth in a decade

European economies thrived in 2017. The spectacular run of strong economic data continued unabated into the end of the year, defying consensus expectations. Economic data surprises relative to market expectations were constantly positive over the past 14 months, the first such occurrence in 15 years.

To illustrate this, the European Commission Economic Sentiment Index reached a 17-year high in November, as sentiment among both consumers and businesses improved. Other indicators such as PMIs, unemployment rates and country-by-country indices paint a similar picture: GDP growth will remain solid in Q4.

As a result, the Eurozone is on track to post its strongest annual growth in a decade, close to 2.5%. This mid-cycle dynamism, for an economy that only emerged from recession four years ago, contrasts with the late-cycle limpness of the US economy. And this is quite likely to extend into 2018.

Eurozone economic sentiment and activity keep surprising positively

Sources: Factset, SYZ Asset Management. Data as at: 8 December 2017

Eurozone economic sentiment and activity keep surprising positively

The BoE reversed its post-Brexit rate cut by hiking in November

Sources: Factset, SYZ Asset Management. Data as at: 8 December 2017

The BoE reversed its post-Brexit rate cut by hiking in November
04

United Kingdom – The BoE hikes the bank rate but remains alert

While negotiations between the European Union and the British government are intensifying, growth remains positive in the UK, albeit at a lower level than before the Brexit referendum. Unemployment keeps declining and at 4.3% is at its lowest level in 42 years.

In the meantime, inflation has been exceeding the Bank of England’s 2% target since February of this year, pushed up by imported inflationary pressures in the first half of the year and rising energy prices since the summer.

This context led the Bank of England to raise its bank rate by 25bps in November to 0.50%, thereby reversing its emergency post-Brexit rate cut. The Bank of England emphasised that monetary policy will continue to provide significant support to the economy, and although it left the door open to further rate hikes, it also emphasised its heightened awareness to the impact of Brexit on households, businesses and financial markets.

05

Japan – Truly out of deflation finally ?

Are we witnessing the revenge of the ‘old economies’? Along with Europe, Japan is also driving the momentum of large developed economies. As confidence runs high among businesses, the re-election of Prime Minister Abe should support the dynamic that has been at play since 2013 and the implementation of Abenomics.

This set of policies, explicitly aimed at dragging the Japanese economy out of 20 years of deflation, has so far proved relatively successful. Real GDP growth reached 2.1% in Q3, fuelled by strong business investment. And perhaps more importantly for a once deflation-ridden economy, nominal GDP growth has resumed an upward trend, after a long period of stagnation during which real GDP growth was met with declining nominal prices. Japan’s GDP has indeed only recently surpassed it 1997 peak. With above-potential real GDP growth and inflation in positive territory, 2017 has been another year of positive nominal growth for Japan, and the trend looks likely to extend into 2018.

Firm real GDP growth and rediscovered nominal GDP expansion

Sources: Factset, SYZ Asset Management. Data as at: 8 December 2017

Firm real GDP growth and rediscovered nominal GDP expansion

Deleveraging has pushed equities lower and rates higher in November

Sources: Factset, SYZ Asset Management. Data as at: 8 December 2017

Deleveraging has pushed equities lower and rates higher in November
06

China – Post-Party Congress blues ?

The remarkable stabilisation of China’s growth has certainly been a positive feature of 2017. Fine tuning monetary and fiscal policy helped Xi Jinping open the Communist Party Congress in October with GDP growth stabilised precisely at his targeted rate. However, data continues to point to the fact that China’s growth relies extensively on credit expansion.

Xi Jinping’s emphasis on quality rather than quantity with regards to GDP growth raises fears that deleveraging might prompt economic activity to slow down. So far, however, early data has not echoed these concerns, as PMI indices continue to show positive, if unspectacular, economic growth.

Nevertheless, targeted measures aimed at financial firms to cool down credit growth may have had a more pronounced impact on Chinese financial markets. In November, the Shanghai Composite fell 4% from a two-year high while government 10-year rates jumped above 4% for the first time in three years, pushed up by deleveraging efforts which prompted forced selling.

07

Fixed income – Turkish bond yields hit new highs

The difference between the spread of Turkish hard currency bonds (i.e. USD bonds) and the spread of the broader emerging markets universe peaked during the month of November to one of its highest levels in recent years (nearly as high as in January). Hence, investors owning Turkish bonds are asking to be compensated with a higher premium compared to emerging market peers.

Recently, the Turkish central bank announced a change in its liquidity policy, which increases the average funding cost for banks by 25bps to 12.25%, to support the Turkish currency’s rapid depreciation (TRY – 12% vs. USD since the end of August).

President Recep Tayyip Erdogan continues to attack the Turkish central bank by criticising its policy of targeting high interest rates to fight currency depreciation and control the ramping up of inflation. Therefore, the Turkish central bank’s independence is very fragile, worsening the country’s outlook as its diplomatic relations with Europe and the United States are already at risk.

J.P. Morgan EMBIG Diversified Turkey Sovereign Spread - - J.P. Morgan EMBIG Diversified Sovereign Spread

Sources: Bloomberg, SYZ Asset Management. Data as at: 8 December 2017

J.P. Morgan EMBIG Diversified Turkey Sovereign Spread - - J.P. Morgan EMBIG Diversified Sovereign Spread

FTSE 100 vs. STOXX 600 and EUR/GBP FX Spot Rate

Sources: Bloomberg, SYZ Asset Management. Data as at: 8 December 2017

FTSE 100 vs. STOXX 600 and EUR/GBP FX Spot Rate
08

Equities – Is the correlation broken between the FTSE 100 relative performance and the EUR/GBP ?

The UK equity market (FTSE 100) tends to be closely correlated with the evolution of the exchange rate: when the GBP depreciates against the EUR (and other currencies), the FTSE 100 generally outperforms the European broad market (STOXX 600). Hence, UK equity markets are inversely correlated to the sterling. Lately, however, this correlation has been fading due to political uncertainty related to Brexit.

Moreover, the Cable has been quite volatile in the run up to Brexit with a settlement that should reach between EUR 40bn and 60bn.

In this context, investors have been repricing UK assets. Yields on gilts climbed higher at the end of November and the pound was pushed to one of its highest level in two months, based on the expectation that the economy will remain strong if the divorce settlement with Europe goes through smoothly.

09

Italy – Yield spread over Germany narrows

The spread of Italian 10-year bonds over German equivalents’ is narrowing as the Italian economy improves. Since 2013, Italy’s economy has continued to surprise economists on the upside, as illustrated by its YOY GDP. Additionally, investors continue to buy Italian debt for the carry that is becoming more and more difficult to find in European government debt.

However, 2018 is very unlikely to be a non-event for investors in Italian paper. General elections will take place next year and the Populist Party, Cinque Stelle, has the potential to surprise. It is also worth remembering that Italian banks continue to have bad debt and toxic assets on their balance sheets, which prevents them from truly supporting growth. Banks must continue to clean up their balance sheets in order for the country to sustain attractive growth levels.

Italian economy getting stronger

Sources: Bloomberg, SYZ Asset Management. Data as at: 8 December 2017

Italian economy getting stronger

Time Warner shares plunged after the WSJ announced the decision of the DOJ

Sources: Bloomberg, SYZ Asset Management. Data as at: 8 December 2017

Time Warner shares plunged after the WSJ announced the decision of the DOJ
10

Equities – Time Warner/AT&T merger blocked for now

The US Department of Justice announced in November that it will block the mega deal between content producer Time Warner and network operator AT&T. The decision of the DOJ came as a surprise to investors as the transaction was announced over a year ago and was analysed in great detail by the US regulator. Time Warner stock prices reacted badly to the news and fell to close to the price it was trading at prior to the merger announcement.

AT&T is planning to sue the DOJ, as the company believes its case for blocking the deal is weak and that its antitrust argument will be dismissed. Additionally, AT&T will most likely require the DOJ to disclose its communication with the White House as Trump was openly hostile to the deal.