OVERVIEW – FACTORS DRIVING FINANCIAL MARKETS IN 2018
Financial markets are in the thrall of positive macroeconomic fundamentals and the longer-term investment implications of a low-rate, low-inflation environment.
The expansion of G3 central bank balance sheets since 2009 has lowered the risk premium in equity, fixed-income, credit and emerging markets. In our view, this could continue, particularly as the aggregate size of central bank balance sheets looks set to continue to increase until late in 2018.
The principal risk we see to this scenario is an abrupt rise in inflation triggering a major correction in debt markets. We ascribe a low probability to this outcome. On the contrary, we expect G3 central banks to continue to struggle to achieve their inflation targets.
In 2018, while we see scope for further gains in risk assets (we do not, for example, consider valuations in equity markets to be excessive), we are cognisant of the risk that ‘capital superabundance can increase the frequency, size and longevity of market overshoots.’1
1 On 14 November 2012, Bain & Company published an extremely prescient report entitled ‘A world awash in money’ explaining the notion of capital superabundance and the risks created as a consequence of long-term intervention by fiscal policy makers and central banks.