The magnitude of the strong beginning to the year has probably surprised even those who were forecasting a positive start to 2018. Despite being just one week into the year, we think there’s a few conclusions to draw already. If we turn the clock back slightly and review the stack of “2018 Outlooks” that we received before Christmas, there was an unusual amount of consensus around the potential pattern of markets for the year ahead:
• Fundamentals were to remain strong in 2018 and the global co-ordinated recovery that fuelled markets in 2017 would remain intact.
• Most agreed that 2019 would be weaker but still no real signs of recession.
• There was also consensus around an intra-cycle correction at some point in 2018, especially as the prior 18 months had not experienced any meaningful pull back in risk assets. Interestingly though, there was almost complete consensus that this might happen later in the year, paving the way clear for a continuation of good risk conditions that we enjoyed during 2017.
Various reasons were cited as the catalyst for this potential correction, ranging from a reduction in central bank stimulus or balance sheet reduction, uptick in inflation, or earnings not keeping up with expectations. All good possible reasons, but none of those catalysts are likely in Q1 2018, and it is this that has empowered investors in the first week of 2018 and the last week of 2017.
Signs were already clear in the usually very calm period up to the New Year when all assets were rising and correlations broke down as investors sought to ensure they were not holding too much cash. This technical picture continued more aggressively as this cash was further deployed into risk assets as 2018 began. We should not be surprised by this, as the cumulative value of the assets on the big four central banks’ balance sheets - which effectively puts cash into the marketplace - stands at around $15 trillion and is still creeping higher at the moment despite the rate hikes seen in the US and UK. Only in 2019 will it start to fall, and even then, only slowly. So far this year, risk off assets have hardly fallen, while this early risk rally has dominated; another clear sign of the cash balances in the market.
The power of this rally is not likely to continue as strongly as markets will shortly be blessed with some fresh supply, but the underlying trend that helped 2017 is certainly still there. For some sectors this technical backdrop may be less strong as the year wears on but for others it will remain. We will touch upon a few of these sectors in upcoming blogs. Meanwhile, we hope everyone is enjoying the rally!