Amid the seemingly endless noise that poses as news, Rick Rieder and Russ Brownback focus in on three of the most critical themes that investors need to consider for 2018.
We’ve often argued that market participants appear to solely fixate on one thing at a time, and moreover their collective attention span appears to be very short, as these things, or themes, continually shift during the course of a year. To that end, we think it might be useful as the year gets going to reflect on a few critical themes that we believe will persist in their importance to markets in 2018. Hopefully, this may aid investors in tuning out the parade of market noise that ultimately won’t matter much to the year’s investment prospects.
1. G3 Monetary Policy Liquidity Slowly Waning; Organic Drivers Should Step Up
A proxy for global liquidity (defined by the year-over-year change in aggregate G3 central bank balance sheets, in U.S. dollars, plus changes in global foreign exchange reserves) grew by nearly $14 trillion from 2008 through 2017, according to Federal Reserve and Bloomberg data as of September 2017. That massive infusion of liquidity helped to restore confidence in both the financial and real economies in the wake of the global financial crisis, yet at this stage, with the global economy enjoying one of its most powerful synchronized expansions since the crisis, it only makes sense that this liquidity be reined in. In fact, we argued that the process should have started a couple years before it did, as it resulted in some significant market distortions and excessive valuations, but nevertheless 2018 will now be an important inflection point for policy.
This raises the vital question, then, of what the prospects are for risk assets under evolving policy liquidity? Overall, we think global growth, fiscal policy and organically derived forms of liquidity will likely more than offset the slow pace of central bank tightening this year. Still, it must be recognized that organically derived liquidity, by its very nature, is more volatile than the kind supplied by central banks, so we fully expect market volatility to rise alongside this transition.
2. U.S. Fiscal Policy More Supportive of Economy/Markets Than Many Acknowledge
At the end of 2017, the U.S. Congress and Administration passed the Tax Cuts and Jobs Act, which represents the most fundamental re-thinking of tax policy in the U.S. in 30 years. Among many other provisions, the Act lowered individual income tax rates, lowered the top corporate rate from 35% to 21%, allowed for the full write-off of corporate capital expenditures through 2023, included a deemed repatriation tax for corporations and shifted the country to a largely territorial tax system, bringing it closer in line with most of the rest of the world. We’re not going to suggest the legislation was perfect, but we do think it is more supportive of the economy and markets than many commentators have acknowledged.