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Market View

The Economic Outlook for 2018

Sanlam’s analysis of what lies ahead

As global investors, we’re feeling optimistic about the economic outlook for the year ahead. Last year ended on a high, with global growth accelerating to 3.7% (source: IMF) - the highest level since the financial crisis, and we’re expecting this trend to continue well into 2018.

A PDF version of Market View is available.

Asia and the US fuel global economic growth

With inflation so low, central banks can maintain the current accommodative interest rate environment, which should support the economic outlook. Growth from Asia, and Donald Trump’s corporate tax plan, are also supporting confidence – a key driver of capital expenditure. Trump’s achievement of lowering corporate tax rates from 35% to 21%, and allowing US companies to bring back their overseas profits at 7.5% tax rather than 28%, will have global consequences. If the US does well, we all do well, since most companies count the US as an important market.

If the US does well, we all do well, since most companies count the US as an important market.” Philip Smeaton, Chief Investment Officer

Optimistic, but mindful of downside risks

While we’re satisfied that the global economy is strengthening, we remain concerned that after eight years of great performance, the price of assets already reflects this positive outlook. The danger is that there’s little margin of safety if the outlook deteriorates, because investments are not cheap. Indeed, it has rarely been the case that equities, government bonds and credit have all looked this expensive simultaneously. That creates the risk of a co-ordinated withdrawal in the event of a market shock.

The Sanlam approach

We begin this year as we ended last – with an optimistic, yet cautious approach. We’ll continue to focus on the longer-term outlook, maintaining a diversified portfolio across a range of global stocks and across the spectrum of asset classes. We take valuation very seriously when purchasing securities on behalf of our clients. While it is a poor market timing tool (shares can stay irrationally expensive or irrationally cheap for periods of time), we believe the price paid for a security has a profound long-term impact on a client’s expected returns.

Our models suggest that securities bought today, at these prices, have significantly lower prospects of strong absolute returns than a year ago.

Outlook by sector

Looking ahead, here is what we think the prospects are for different sectors, and how they might contribute to clients’ investment portfolios this year.

Healthcare

This sector is feeling somewhat unloved right now, with uncertainty over the future of Obamacare causing investors to steer clear.

Opportunities
As the global population becomes wealthier and longevity improves, there is a huge opportunity for healthcare companies to grow their revenue. Innovative therapies and new medicines are protected by patents, and the industry generally holds up well during recessions.

Threats
While overhauling Obamacare doesn’t change the investment case for the sector in the long term, there could well be more volatility ahead as this process runs its course. Investors need to be very careful when investing in this sector as the cost of developing new products is high, and there is no guarantee that new products will make it to market.

Sanlam Outlook
We think the outlook is good for this sector. We’ve been adding to some businesses, such as Medtronic and Roche, as they appear cheap relative to the other investments we could buy. Medical devices are particularly attractive as the pipeline of new products is more predictable.

Information Technology

The technology sector has come of age, finally delivering on the promise that created the dotcom bubble. The outlook for the sector is good, as products that are built on a strong IT infrastructure are very difficult for competitors to disrupt. And even when they do, larger firms have been acquiring challengers before they become rivals. While shares have become gradually more expensive, earnings have also increased, in many cases justifying their valuations.

Opportunities
Companies in this sector still have the wind behind them as people become more and more comfortable operating online. As they gain customers, they become even more profitable as it usually costs very little to add extra users once the framework is created.

Continuous improvement in hardware (like mobile phones) allows companies to sell more and more products through their technology channels.

Threats
Most tech businesses have had the benefit of being able to setup offshore, benefitting from tax breaks. US tax cuts will create a more level playing field with on-shore rivals, enabling them to better compete with their online counterparts.

Also, tighter regulation of these IT businesses is inevitable, and it’s not clear what the impact will be.

Sanlam Outlook
The outlook for this sector is good, and we expect technology stocks to continue to play an important part in client portfolios. We will be looking out for buying opportunities if tech stocks fall out of favour due to the tax cuts.

Retail

Global consumer confidence levels are at their highest since 2001 (source: Bloomberg), and retail sales are expected to continue their upward trend of 2017. A growing economy, and the positive impact this has on the global economy, should benefit this sector.

Opportunities
Concerns about the shift to online shopping means that this sector is cheap, which is always a good starting point. Retail companies based in the US look set to benefit from the corporate tax cuts. Apart from having a lower tax bill, they’ll be able to compete more effectively on price with their online counterparts.

Threats
Online, online and online. Companies that fail to develop a strong online offering are very vulnerable to losing market share as consumers are shifting aggressively in this direction. Also, both domestically and abroad, inflation and higher interest rates will inevitably hit the consumer purse.

Sanlam Outlook
We’re cautious of this sector, and would rather access consumer spending growth in other ways. There are some unique businesses that are interesting, such as Pandora, which have been sold down together with other retailers, but in general we are cautious.

Financials

The global financial services sector has not had it easy in recent years. Low interest rates, low inflation, and regulatory burdens have restricted profit margins and made ‘doing business’ increasingly expensive. But as the global economy recovers, that could be about to change.

Opportunities
The prospect of higher interest rates is a key driver of optimism for this sector as it means banks will make more money from the loans they provide. In addition, Trump’s tax changes will be hugely welcomed. De-regulation will liberate US financial institutions, and tax reform will mean large sums of money coming on-shore, creating demand for US banks.

Threats
Because banks are leveraged, and because they lend to all industries, they are always vulnerable to any wobbles in the economy. As interest rates climb, it is possible that imbalances that have built during the years of ultra-low rates are exposed, which would hurt this sector.

Sanlam Outlook
We think 2018 could be a good year for financial services businesses. But because banks are highly leveraged, we’re generally reluctant to own them, and prefer to get exposure through higher quality financials such as card companies (Visa, American Express, etc.) or service businesses like Moody’s (the rating agency).

Commodities

Commodity prices held steady in 2017. With Saudi Aramco likely to list in the second half of 2018 we would expect OPEC to remain firmly behind oil prices for the foreseeable future. In other commodities prices are generally at levels where most mines are profitable, so it’s not clear if further supply will be removed, supporting prices further, or if the outlook is more tempered.

Opportunities
Saudi Arabia looks set to list 5% of a state-owned oil company towards the end of 2018. It’s thought they will do everything they can to keep oil prices elevated until that happens.

Threats
While China had a great 2017, it’s likely they will experience something of a breather this year. That could mean less spend on infrastructure and therefore less demand for commodities, such as steel.

Sanlam Outlook
Like construction, the cyclical and very capital-intensive “all or nothing” nature of commodity businesses means we don’t like to be too exposed to this sector. It’s hard to make enough of a return to justify the risk we would have to take.

Construction

A growing economy is always a boon for the construction industry as it can mean greater infrastructure spending, and more property development. The sector is still reliant on several decisions going its way though.

Opportunities
One of Trump’s proposed tax reforms is to temporarily allow large one-off investments to be written off in a single tax year, giving companies the opportunity to dramatically reduce their tax bill. The construction industry may well be a beneficiary of this, as companies are forced to fast track investments in expanding capacity.

Threats
As always, construction companies are at the mercy of the economic cycle. So, while they are looking good right now, they need to see some of the economic promises coming to fruition to justify current valuations.

Sanlam Outlook
We continue to be cautious of this sector, as the cyclical and capital-intensive nature of these businesses renders them unattractive in the long-term.

Bonds

Bonds continue to offer low yields, with many government bonds paying less than inflation, even over 5 to 10 years. That said, they tend to perform when other assets are doing badly, so they remain important for portfolio diversification.

Opportunities
Pension funds and banks need to own bonds to match the liabilities of an aging population.  Government bonds will therefore continue to be in demand as they offer the greatest level of certainty. Corporate bonds are also looking reasonably attractive as businesses are less likely to default in the current environment, and they are not as sensitive to interest rate hikes.

Threats
Bond spreads are very narrow, meaning there is little extra reward for investing in poorer quality bonds. So riskier bonds, such as high yield bonds, are looking particularly unattractive although, as is the case with equities, there are always pockets of value that we strive to access.

Sanlam Outlook
Bonds are one of the core building blocks of client portfolios. Despite them being expensive we still think that investors can earn acceptable returns. Within bonds we predict that corporate bonds offer the best opportunities going into 2018.

A PDF version of Market View is available.

Investing involves risk and the value of investments and the income from them may fall as well as rise and are not guaranteed. Investors may not get back the original amount invested.