mid year outlook

By Jeffrey Kleintop, Charles Schwab & Co.

Key points

  • Many of our top risks for 2018 have come to pass.

  • Our updated top five global risks for investors in 2018 are: geopolitics, chasing returns, the return of inflation, dollar strength, and fading momentum.

  • Having a well-balanced, diversified portfolio and being prepared with a plan in the event of an unexpected outcome is a key to successful investing.

In our Five Global Risks for Investors in 2018 published at the start of the year, we offered a list of the top five risks, that we are now updating:

1. Geopolitics

2. Chasing returns

3. Return of inflation

4. Dollar strength (replacing Private investment boom)

5. Fading momentum (replacing Natural disasters)

In this mid year outlook, we will review where these risks stand and see if any new risks make the top five. We’re dropping “private investment boom” and “natural disasters” from our top five, replacing them with “dollar strength” and “fading momentum”.

1. Geopolitics

Geopolitics remains the top risk for investors this year.

As we noted at the beginning of the year, ahead of any tariff implementation or escalation of trade battles:

“Entering 2017 many investors were intensely focused on geopolitics after the Brexit vote and the U.S. election, but the acceleration in global growth outweighed any potentially negative impact from either trade disputes or military threats. The opposite could happen in 2018.”

The opposite has taken place: a slowdown in global growth combined with escalating trade conflicts weighed on stock market performance in the first half.

While geopolitics remains high on our list of risks, it is worth noting that the threat of military conflict with North Korea, considered a big risk by many at the beginning of the year, de-escalated quickly. In fact, one year ago President Trump threatened North Korea with “fire and fury like the world has never seen.”  In response, North Korea announced its plan to fire missiles at Guam. Ultimately, there was no military action and tensions cooled. In a similar way, the second half of the year might see a de-escalation of trade conflicts, as world leaders negotiate away from a potential trade war.

2. Chasing returns

Chasing returns remains a consistently predictable investor behavior and a top risk for 2018.As we had warned at the start of the year:

“In our 2017 outlook, we pointed to the turnaround in the five-year return for global stocks as a clear signal of the rebound in net buying of equities that took place last year. In 2018, that trend may reverse.”

It has reversed, as forecasted by the slump in the five-year rolling return for stocks.

Without the aid of advice and a financial plan, investors often tend to chase returns. The rolling five-year return has most closely mirrored investors’ buying and selling of stock funds (mutual funds and exchange-traded funds combined). Investors’ buying has faded this year and the five-year rolling return for the stock market is likely to continue to fall as it rolls off the strong returns in the second half of 2013, suggesting continued weakness.

3. Inflation surprise

An inflation surprise that forces central banks to raise interest rates more quickly than expected remains a top risk.

Because risk is often hiding in plain sight, we cited complacency on inflation and the related policy moves that have historically ended many past economic and market cycles as a risk at the start of this year:

“Yet, few expect any uptick in inflation next year. The economist and market consensus is that inflation will remain the same as in 2017. In fact, to use the U.S. as an example, of the 74 economists tracked by Bloomberg only five expect even a half of a percentage point rise in inflation in 2018.”

Inflation has jumped in 2018 to a year-over-year pace of 2.9% after ending 2017 at 2.1%.

More of the world’s central banks are hiking rates in 2018 than at any other time in the past six years. This increases the risk of an inverted yield curve in the coming year, a historically reliable indicator of global recessions and bear markets.

4. Dollar strength

A sharp and sustained rise in the value of the U.S. dollar poses a risk to global investors in 2018.

The value of the U.S. dollar rose sharply beginning in April after falling steadily in 2017. A continued rise in the dollar could act as a drag on the dollar-based returns of non-U.S. investments. It may also escalate trade tensions if other countries are seen as weakening their currencies to win a trade advantage against U.S.-based competitors. A result could be tighter global financial conditions, contributing to slow growth and financial stresses.

5. Fading momentum

The fading global economic momentum this year was not unexpected but could pose a risk to investors if deceleration continues and momentum fails to stabilize.

The economies of Europe and Japan are expected to slow this year to a more sustainable pace of growth after above-average growth in 2017. China also continues to see its economic momentum fade. The pace of these slowdowns caught many economists by surprise in the first half of the year as the economic data widely missed economists’ expectations.

Based on the global composite purchasing managers index (PMI), a timely reading of economic conditions around the world, the economic deceleration appears to have stabilized. Reflecting steady and solid global growth for much of 2017, the global PMI jumped late in the year and then slowed sharply in early 2018, as you can see in the chart below. The global PMI has stabilized following the drop, but the risk of a renewed decline cannot be ruled out.

Downgraded risks from the top five

We noted at the beginning of the year that the chase for yield led:

“Investors to increasingly turn to exploiting the spread between public and private assets, known as the liquidity premium, fueling a boom in private assets that aren’t traded in public markets such as private equity, private debt, commercial real estate, and direct lending.”

We are downgrading this risk from the top five, given that there are few signs of a downturn in these assets that could spill over into publically traded stocks or bonds.

Natural disasters remain a concern, but it also no longer makes our top five. After 2017 ranked as the most costly year ever for natural disasters, we wrote that:

“An increasing wave of disasters may mean the repeated costs of rebuilding start to outweigh the boost to growth. That could lead to a change to the muted way markets have historically reacted to disasters.”

While 2018 has also seen its share of tragic natural disasters and the Atlantic hurricane season is not yet underway, it appears that 2018 may not repeat 2017’s devastation.

Be prepared

It’s best to close with a reminder of two key takeaways from the beginning of the year that still hold true in our estimation:

“A global recession would be a big risk for stocks. While the global economic cycle is aging, we don’t foresee a global recession taking place in 2018 — although that risk may rise in 2019.”

“Whether or not these particular surprises come to pass, a new year almost always brings surprises of one form or another. Having a well-balanced, diversified portfolio and being prepared with a plan in the event of an unexpected outcome is a key to successful investing.”

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About LRPC’s Monday Morning Minute

Lawton Retirement Plan Consultants, LLC (LRPC) Monday Morning Minute is crafted to provide decision-makers with important information about the economy, investments and corporate retirement plans in a format that allows a reader to consume the information in less than 60 seconds. As an independent, objective investment adviser, LRPC has access to many sources of research and shares the best and most relevant information with its readers each week.

About Lawton Retirement Plan Consultants, LLC  

Lawton Retirement Plan Consultants, LLC (LRPC) is a Milwaukee, Wisconsin-based independent, objective Registered Investment Adviser (RIA) providing investment advisory, fiduciary compliance, employee education, provider management and plan design services to employer retirement plan sponsors. The firm specializes in Socially Responsible Investment (SRI) strategies for retirement plans and is a pioneer in the field. LRPC currently has contracts in place to provide consulting services on nearly $475 million in plan assets. For more information, please contact Robert C. Lawton at (414) 828-4015 or bob@lawtonrpc.com or visit the firm’s website at http://www.lawtonrpc.com. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser.

Important Disclosures

This information was developed as a general guide to educate plan sponsors and is not intended as authoritative guidance, tax, legal or investment advice. Each plan has unique requirements and you should consult your attorney or tax adviser for guidance on your specific situation. In no way does Lawton Retirement Plan Consultants, LLC assure that, by using the information provided, a plan sponsor will be in compliance with ERISA regulations. Investors should carefully consider investment objectives, risks, charges, and expenses. The statements in this publication are the opinions and beliefs of the commentator expressed when the commentary was made and are not intended to represent that person’s opinions and beliefs at any other time. The commentary does not necessarily reflect the opinion of Lawton Retirement Plan Consultants, LLC and should not be construed as recommendations or investment advice. Lawton Retirement Plan Consultants, LLC offers no tax, legal or accounting advice and any advice contained herein is not specific to any individual, entity or retirement plan, but rather general in nature and, therefore, should not be relied upon for specific investment situations. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser and accepts clients outside of Wisconsin based upon applicable state registration regulations and the “de minimus” exception.

Additional Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve. The MSCI ACWI captures large and mid cap representation across 23 Developed Markets and 24 Emerging Markets countries. With 2,781 constituents, the index covers approximately 85% of the global investable equity opportunity set.