Barring a late year sell-off, 2017 will be another year of positive returns and historically low volatility. Overall the world’s economy seems to be humming along and there are few indications that volatility will pick up in the short-term. Yet it is important to remember that late cycle stability is an easy period to become complacent, the last similar market conditions were in 2006 and clearly did not last long. As we look towards the future, there are three main questions we have.
Our first revolves around the United States. The U.S. has been a model for recovery since the financial crisis and has consistently reached new highs year after year. Inflation has remained modest and questions remain whether 2018 will be the year it finally ticks higher or will it continue to succumb to deflationary pressures. With unemployment so low, there are fewer workers that can be added to the workforce to expand productivity from a labor perspective. Tax law changes will most likely dominate headlines and whether there is enough political wisdom to enact policy changes that will improve the outlook for both the American corporation and individual.
The second will be regarding the world’s central banks and their ability to exit from the extraordinary measures they took over the past decade. One of the most difficult parts of analyzing the potential outcomes of reducing their balance sheets is that historically there is no precedent for actively reducing them. So far the market has taken the Federal Reserve’s decisions in stride and the ECB has indicated that they will reduce their bond purchases next year. To complicate the matter, Yellen’s position as Fed chair could be in jeopardy depending on how the current administration decides to proceed early next year. A dramatic shift in leadership could send ripples throughout the world’s economy.
Our last concern has faded to the back of most headlines but it is important to remember how large of a role they continue to play in the world economy. China is installing a new party Congress this month and many questions remain on how they will proceed regarding their own economy. It could be that their focus remains on stability and that they will continue to use their reserves as a tool to manage volatility. However, there is the possibility that they continue changing policy towards their state-owned enterprises which would open the door to many different outcomes. Also as their influence continues to expand, the risk of a trade conflict with the United States grows especially with the hostile tones from the U.S. administration regarding trade policy.
With the uncertainty of some major portions of the macro environment combined with tight valuations, a cautious approach continues to be our recommended positioning. Nothing is ever certain and a balanced approach to portfolio construction is the best way to ensure your investment goals are met in this type of economic climate. Remember that investing is a marathon and not a sprint and grinding out investment returns is the safest way to generate positive outcomes instead of trying to predict the future.