Global growth accelerated in 2017 as the key drags on growth of the last few years, Japan and Europe, finally participated in the cyclical up-turn in growth. Stability in China and the end of protracted recessions in Brazil and Russia also helped. Offsetting the good news, the UK hasn’t enjoyed the same degree of pick-up in growth as Brexit uncertainties weigh on sentiment. India had a sub-par year as demonetisation and the introduction of a goods and services tax saw the economy underperform its potential.
On average though it was a good year for the global economy with GDP growth estimated at 3.6%, up from 3.1% in 2016 and its highest level since 2011. This helped drive strong profit growth over the year which was a key positive for business confidence, investment and equity markets. This is an important factor as we head in to 2018, as higher business investment remains a necessary condition for prolonging the cycle.
While growth was picking up, inflation still failed to fire. In fact, core inflation went through a mid-year wobble that saw the annual rate in the US dip back below 2%. Towards the end of the year inflation seems to be heading higher again.
Belief that the weak patch in inflation would ultimately prove transitory saw the US Federal Reserve (the Fed) continue its monetary policy normalization, with interest rate increases in June and December and an announcement in September that it would soon start to wind back the size of its balance sheet – in other words quantitative tightening.
The central banks of England and Canada raised interest rates, but in both cases this was due to the removal of prior ‘emergency’ cuts, Brexit in the case of England and lower oil prices in Canada, rather than any sign of sustained upward pressure on core inflation. Both will be cautious about the further removal of monetary stimulus. Europe and Japan remained in stimulus mode, though the European Central Bank announced a reduction in the quantum of monthly asset purchases for 2018.
The US dollar (USD) was generally soft during the year as weak inflation led markets to continue to question how much more tightening the Fed would be able to do. At the same time, a number of other central banks were beginning the long slow normalization of their own policy settings. Domestic politics, particularly the Mueller probe into the Trump election campaign’s links with Russia, also weighed on the USD.
Generally speaking though, international political risks came to nothing in 2017. Eurozone elections were benign in the end as pro–Europe centrists dominated. Geopolitical risks largely manifested in the form of North Korea, though none of that news had any lasting impact on markets. The Republican loss of the Alabama Senate seat sets up fascinating mid-term elections next year.
China enjoyed a period of relative stability in 2017.Growth in 2017 looks set to come in at around the same level as 2016. The goal for this year was stability as the Communist Party held its 19th five-yearly Congress that saw President Xi Jinping cement his hold on the Chinese leadership. A gradual tightening in financial conditions was starting to weigh on activity late in the year, which appears to signal a resumption of the gradual slowdown in growth in 2018. We expect the reform process to also step up in 2018.
A change of Government in New Zealand heralded a period of policy uncertainty. Business confidence and the (trade weighted) New Zealand dollar ended the year lower. The economy had a solid year, though growth was constrained to some extent as a number of sectors hit capacity constraints particularly residential construction. Inflation remains subdued with the Reserve Bank of New Zealand firmly in neutral.
The so-called ‘Goldilocks’ combination of stronger global GDP and profit growth, benign inflation and still stimulatory monetary conditions saw global shares push sharply higher in 2017. Furthermore, volatility was low. Any pull-backs were shallow and short-lived and didn’t provide the much desired opportunity to purchase some cheaper assets.
The New Zealand share market had another solid year driven by a solid economic performance and reasonable earnings growth. By contrast, the Australian share market continued to lag given the weaker underlying profit growth.
Emerging market shares were the strongest performers, benefiting from the trifecta of a strong global economy, the resultant pick up in commodity prices and weakness in the US dollar as sentiment towards the Fed hikes did more waning than waxing.
As expected, bond returns had a tepid year. While inflation remained largely missing in action, low yields constrained returns.
Looking ahead to 2018, we retain a positive and constructive outlook for markets. That said, the meaningful correction we have been talking about for most of 2017 is yet to transpire. The key question for 2018 is how long the upward growth momentum can last. Critical to that is the outlook for business investment and productivity. We remain optimistic on that front. The inflation and monetary policy outlook will determined by the extent to which tighter labour markets and increasing wage pressure is offset by improving productivity. China will also be back in the spotlight as the reform process shifts up a gear and the leadership continues to shift the focus from the quantity to the quality of growth.
For more on the outlook for 2018 and the implications for markets and investment returns watch out for the January edition of Quarterly Strategic Outlook, followed shortly thereafter by our Investment Outlook roadshow in February. In the meantime, have a great Christmas and all the best for a prosperous 2018.
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