These are the areas investors must watch in 2018

It’s nice to start the New Year with a bang, although, in political terms, that may not be the ideal way to usher in 2018, with geopolitical risk and North Korea ever present. Closer to home, we are spoilt for choice for political and economic distractions.

Forget Brexit for a minute, soaring inflation and weakening wage growth are more immediate concerns. Trump may actually be turning rhetoric into decisive action, but tax reforms may prove a false dawn.

After Roy Moore’s defeat in the Alabama Senate election, Trump’s job may also be about to get a lot harder. As entertainment in the gloomy post-Christmas period, it would be apt to start with Trump as we look forward to the rest of 2018.

US

There is little doubt that the new president has helped to usher in a period of fresh investor and economic optimism. GDP growth is at three-year highs, unemployment is at 17-year lows and the equities bull run turned into a stampede. This bullishness on America is clearly infectious, with many analysts predicting a Trump Bump 2.0 this year.

Although the Federal Reserve anticipates GDP growth of 2.5% in 2018, bulls feel this errs on the side of caution. Tax reform is a primary source of upbeat sentiment. The White House Council of Economic Advisers recently noted that a corporate tax rate of 20% could increase the average annual American salary by over $4,000 as economic growth accelerates.

While it is easy to be seduced by the pro-business mandate becoming reality, the more discerning will raise the question of Roy Moore. It could be argued that Trump’s position has now been compromised in a manner which has far greater ramifications than the loss of one Republican vote.

The 51-49 majority in the Senate may just prove to be the tip of the iceberg. Not only will legislation become increasingly difficult to pass, but this loss provides graphic evidence of Trump’s limited influence in key Republican strongholds. This may serve to embolden the Democrats in efforts to galvanise voters against one the least popular presidents in history.

From a Republican perspective, the focus may turn towards political self-interest rather than undivided Trump loyalty. The additional leverage gained from Democrat Doug Jones’ victory in Alabama may translate to significant Trump concessions if votes are to be secured. While the Trump Trade may yet benefit from renewed impetus in 2018, there are extra potholes in the road.

In Deceber, the Fed raised US interest rates for a third time in 2017, taking the fed funds rate to 1.25-1.5%. Furthering tightening is expected in 2018, with the Fed anticipating a further three rate rises over the next 12 months. This process of normalisation should see the benchmark rate in the 2% range when 2018 draws to a close. This infers that officials are quietly confident about the progress of the US economy.

However, this will need to be carefully balanced with the unwinding of quantitative easing (QE), as the first tentative steps towards the ‘new normal’ are taken. Fed Chair Janet Yellen is cautiously optimistic as she prepares to step down. Speaking after December’s announcement, Yellen stated, “There’s less to lose sleep about now than has been true for quite some time, so I feel good about the economic outlook.”

North Korea

Although geopolitical risk in Europe has reduced, there is plenty happening elsewhere to keep investors awake at night. As far as North Korea is concerned, the stakes are much higher.

As nuclear testing continues, Kim Jong-Un remains in the headlines for all the wrong reasons. In 2018, expect more worrying times as he remains steadfast in his ambition to make the fledgling state “the world’s strongest nuclear power.”

While the thought of an actual nuclear attack remains inconceivable, the North Korean leader is putting pressure on the US, while China still provides support. In a warning to Trump earlier this month, North Korea stated, “We do not wish for a war but shall not avoid it”. Ultimately, we can only hope that these growing political tensions do not escalate beyond a war of words.

Russia

One person that Trump appears to be on more cordial terms with is Vladimir Putin. Revealing that the leaders are on first name terms at a recent press conference, Putin added, “This is how relations should be between people like us.”

The Russian leader is seeking re-election in March, which would be his fourth overall term as president. A Putin election victory in 2018 is practically a certainty, but geopolitical risk remains. The EU has been largely unsuccessful in its attempts to pressurise Putin to ensure pro-Russian separatists cease the conflict in Eastern Ukraine.

Consequently, the EU has extended economic sanctions against Russia for another six months for its role in the conflict and the misappropriation of Ukrainian state funds.

With the FIFA World Cup starting in June, Putin may be reluctant to create any further geopolitical tension that could lead to boycotts. Oil prices have clearly been in recovery mode as a tightening market continues to rebalance, having hit two-year highs above $64 a barrel as a vital North Sea pipeline shut down.

While tightening is likely to continue, any market reversal in 2018 could increase public dissatisfaction with the Kremlin. Additionally, the risk of major protests after a Putin victory may force him to flex his political muscles. The fallout from any such actions could adversely impact his legitimacy and increase tensions with the West.

UK

Within the UK, economic growth will lose further momentum in 2018 as the nation nervously awaits the outcome of Brexit trade negotiations. Our very own Office for Budget Responsibility expects overall GDP growth of 1.5% in 2017, dropping back to 1.4% this year.

Having kept the base rate on hold at 0.5% in December, the Monetary Policy Committee (MPC) appears to be content with the prospect of a further two rate rises in 2018. Of course, should economic conditions deteriorate more than anticipated, they may rip up that plan.

Inflation has hit five-year highs of 3.1%, but the Bank expects this to gradually move back towards to the 2% target level in 2018 and 2019. The central bank’s outlook for the economy and living standards remains relatively bearish, stressing that economic growth above 1.5% will drive inflationary pressures.

Wage growth has yet to benefit from the lowest unemployment rate since 1975 and, financially, vulnerable households will be looking towards a pickup in their earnings in the New Year.

Business investment remains stagnant due to Brexit headwinds, despite a relatively favourable backdrop of solid global growth and cheap finance. Smooth progress in securing a mutually beneficial EU trade deal could hopefully encourage businesses to revisit any investment plans put on hold.

There are some bright spots with an upturn in manufacturing growth in recent months and, although services growth has slowed, it remains in expansionary mode. These trends are likely to continue in 2018, with weakness in construction persisting.

Eurozone

As the UK economy begins to falter, it would appear that the Eurozone is very much in the ascendancy. Q3 growth for the Euro area was 0.6%, with an expected growth rate of 2.2% in 2017 representing the fastest pace of expansion since 2007. Accommodative monetary policy, a rebounding employment market and strong external demand should all continue to be positive drivers for the region in the forthcoming year.

The major players are leading by example, with GDP forecasts for France, Germany and Italy all upgraded recently. There appears little to dampen the region’s festive spirt, although political risk remains this year.

Accustomed to being the impregnable and irresistible economic heavyweight of Europe, Germany is showing the first chinks in her armour for quite some time. Three months after elections, Angela Merkel does not appear to be any closer to forming a coalition government.

Indeed, we may have to wait until Q2 before this political stand-off is resolved and normal service can resume. In the meantime, Germany’s influence within the EU is being compromised, important decisions are being put on hold and populist opposition towards Germany’s parliamentary system is starting to gain traction again.

The situation in Spain remains delicate, too, as the government and Catalan regional authorities remain in dispute over the potential independence of the region. Italian elections are looming, with voters likely to return to the polling stations in early 2018.

While interest rates are likely to be kept on hold until after QE ends, any unwinding of the ECB’s balance sheet in 2018 will need to be handled with a great degree of caution.

China

No assessment of 2018 would be complete without taking a look at China. With President Xi Jinping having reinforced his leadership credentials, reform is very much on the agenda. Primary goals for 2018 and beyond include reducing industrial capacity, addressing the problem of property speculation and reining in credit growth.

The country’s transition from manufacturing to services-led economy will gather pace in 2018, with China gaining global prominence from an innovation perspective. Political risk remains a consideration as China continues to lock horns with the US in the battle for economic dominance. Xi must balance reforms and the process of gradual financial deleverage with economic stability.

These headwinds will see economic growth slow in 2018, but Joseph Zveglich of the Asian Development Bank still anticipates GDP expansion of 6.4% in 2018. If Zveglich’s projections are accurate, World Bank data indicates that this “controlled moderation” would result in China’s slowest growth rate since 1990.

2018 promises to be an interesting year for markets and the UK is no exception. While a transitional period is inevitabile, this time next year we will be only three months from the EU exit date. Investors can only hope that in the intervening 12 months, a dark cloud of uncertainty will have been replaced with an air of renewed optimism.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Source.