With the new year 2018 comes new optimism, with the continued upward march in global stock markets, and as growth seems set to pick up almost everywhere in the world.
Some analysts continue to advise to the possibility of a bubble, pumped up by artificial and unsustainable monetary stimulus.
Questions: Are we in a bubble about to burst? Or this is the adequate policy (after 2008, and with no high levels of inflation on the horizon) to strength the expansion of economic activity? And consequently decrease the unemployment rate in many countries all over the world?
Stock Market Outlook: If easy money continues, the party will go on
As we all know the major central banks in the world continue to have near zero interest rates. That means easy money is still out there. A lot of it. Or if you prefer another expression: low borrowing costs.
The US Federal Reserve, which was the first in the post-crisis (2008) experiments with zero interest rates and Quantitative easing (QE), began to reduce its purchases of long-term securities at the beginning of 2014, stopped QE completely later that year, and started raising interest rates in 2015. All this without – apparently – producing negative effects on the economy.
The current federal funds rate is 1.5 percent. Some say that it can increase to 2 percent in 2018, and 2.5 percent in 2019. And so on. If this comes to reality it means that they will increase very slowly.
I believe that other central banks will do just about the same thing. Eventually.
If this becomes reality, I believe that is very difficult to see a major crash – without a relatively short rebound immediately after.
The one thing that can sharply change this outlook is inflation. If it shows up (meaning: levels of inflation superior to target of the central bank and rising faster than in the past), central banks will take action before we are expecting them to. And strong action.
Right now, the reality is that for example the MSCI All-Country World Index gained 0.1 percent (08-January-2018), reaching the highest level on record with its sixth consecutive advance.
Personally I’m fan of attributing % to our assets. So if someone defines that stocks shouldn’t be more than 50% of my total investment portfolio, and if due to this recent increase it’s way over 50%, I would immediately sell to get back at a level that I’ve specified. I prefer to buy the dips.Discipline is the mother of any reasonable decision-making process.
Bond Market Outlook: Interest rates will decide everything
The bond market is defined by the interest rates. If we stay permanently in a low interest rate environment – like Japan in the last decades, then I don’t anticipate any strong change on this market. Thus I believe that we will continue to see low levels of volatility, specially on the high-grade bonds.
One could argue that with low volatility comes low returns. However keep in mind that in a diversified portfolio, having a decent allocation to bonds, could be crucially to compensate the volatility of other assets. Consequently stabilizing the overall portfolio.
I would keep a % of bonds (high-quality) to serve as a cushion for an unexpected crash on stocks, real estate, commodities or others high volatility assets.
Ammunition to buy the dips.
Commodity Market Outlook: The roller coaster will continue
OIL: One thing that still remains the same, is the high volatility of Oil. If we compare the OIL (iPath S&P GSCI Crude Oil) with the SPY (SPDR S&P 500 INDEX) we see a brutal difference in the volatility throughout 2017.
30.5% vs 6.7% (OIL vs SPY)
In the first part of 2017 we saw a strong decrease in the value, and then, when everyone was already predicting the death of this commodity, from the ashes it was reborn.
It has been like this for decades.
Yes I do believe the electric vehicle and in renewable sources of energy. Strongly.
On the other hand I believe that mankind will continue to depend on oil for decades to come. And the introduction of the electric vehicle and other initiatives will be offset by the rising of the world population. Therefore we will continue to see a strong demand for oil. Specially on emerging markets. Maybe not so much on developed countries.
Now in terms of the value of oil, well that’s a different story. On that aspect I don’t even try to anticipate what the value will be. It could hit the $120/barrel or it can go down to $15/barrel. Now it’s in the $60 level from a $40 level in the middle of 2017.
For those who like roller coasters, enjoy the ride.
GOLD: Pretty much like Oil, in this commodity we continue to see some superior volatility when compared with stocks.
If you compare GLD (SPDR Gold Shares) with the SPY the volatility in 2017 was: 9.9% vs 6.7%
The discussion around Gold being a valuable asset for a portfolio remains.
I would say that is very difficult to predict the value of these type of assets. So again, if you like roller coasters, enjoy the ride.
Real Estate Market Outlook: If easy money continues, well…you know the drill
Strangely if we compare the VNQ (Vanguard MSCI U.S. REIT) with SPY, in 2017 in terms of volatility we had 10.1% vs 6.7%. In terms of returns it was 4.9% vs 21.7%. Apparently US real estate returns are dismal.
On the other hand for the VNQI (Vanguard S&P Global ex-U.S. REIT) we had less volatility and a much higher total return: 26.9% vs 21.7%.
What I do believe that is actually happening is that with all this easy money floating around, the prices of real estate on major cities are sharply increasing when compared with other small and medium peripheral cities for the same country.
This is what’s happening in Portugal for example, where the real estate price in Lisbon (capital) is getting out of hand, and way above the possibilities of the average Portuguese buyer / investor. I think we can extrapolate this event to other major UK, and European big cities.
So if this upward trend continues, we may see real estate prices on other medium and small cities rise as well. However if the actual prices in big cities are in bubble territory, we may actual see a small burst, as new buyers in 2018, refuse to pay so much for real estate.
It’s too “foggy” right now to see where real estate is going.
Navigating Uncharted Waters
One thing we can say with confidence is that market expectations about what may happens in the long term are strongly influenced by short-term cyclical conditions that were presently created.
So if we continue with a consistent growth of the economy, low levels of unemployment, low borrowing costs, subdue volatility and strong optimism about the future, we may see asset prices, like stocks or real estate, rise rather than fall.
On the other hand if some geopolitical event happens all of the sudden out of nowhere, or if inflation starts to increase dramatically, all bets are off.
Passive Sources of Income
To overcome these hurdles on the investment world, my advice is to not rely solely on stock market investments returns for your retirement.
In the modern world, it’s never been so easy to create passive sources of income, like an online business for example.
To increase our stability in the long term, our income must be far superior to our expenses. And our savings have to be safe and protected.
Readers, what are your thoughts about the financial markets? How are you positioned for 2018? Don’t forget to do your own research and invest based on your own risk tolerance.
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