Midyear Economic Outlook

July 25, 2018

We think this bull market has some life left in it, but the risks to the equity market now seem more balanced than skewed to the upside.

  • We believe that the global economy is sound and that the political uncertainties currently roiling markets will probably be contained.
  • That said, we are becoming more attentive to the possibility of negative surprises and the downside risks to the outlook.
  • A broadening of U.S. trade actions could have a severely negative impact on the profitability of U.S. manufacturers and lead to higher inflation. Rising interest rates intended to counter inflation could compound this unwelcomed scenario.

Global economic fundamentals remain strong

Midyear outlook transcript

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Hello, I’m Jim Solloway, Chief Market Strategist and Senior Portfolio Manager in SEI’s Portfolio Strategies Group.

Today I will be sharing our expectations for the global economy and financial markets over the coming months.

Investors were raging bulls at the beginning of 2018 as equity prices vaulted higher. But that optimism faded dramatically as the news flow turned less favorable. As far as we’re concerned, that’s okay—because the potential for a meaningful advance in equities is greater when investors are pessimistic.

We believe that the global economy is sound and that the political uncertainties currently roiling markets will probably be contained. In our view, investors should remain exposed to equities and other risk assets and ride out the short-term ups and downs. That said we are becoming more attentive to the possibility of negative surprises and the downside risks to the outlook.

Overseas, the picture is not quite as bright as it has been in the U.S. The economic data coming out of Europe has been disappointing in 2018, and analysts project low earnings-growth estimates for companies in the region. Yield spreads may widen as the ECB terminates its asset purchase program and investors demand a risk premium for those countries with a heavy debt burden relative to the size of their economy.

Despite wending its way through an economic soft patch, Great Britain still exhibits solid underlying growth, suggesting that the economy is stable. However, the U.K.’s looming withdrawal from the EU remains a major source of uncertainty. The rising odds of a hard Brexit and greater disruption of British trade with the EU may lead to further downside volatility of sterling versus the U.S. dollar. In the U.S., tax reform, tax cuts for households, and reduced or modified regulation of various industries have led to record-high consumer and business confidence. 

However, trade tensions between the U.S. and China loom over the global economy, and it doesn’t appear that the Trump administration will shy away from ratcheting up the pressure.

Meanwhile, the performance of emerging market assets has been hurt by trade war prospects, rising U.S. interest rates, and recent economic weakness in Europe and China. Still, we’ve yet to see any widespread deterioration in economic performance or financial conditions.

The headwinds blowing in the face of risk assets have picked up. Business activity has slowed a bit, monetary policy is getting tighter or less expansionary, inflation and oil prices have ticked up, and developing countries’ currencies have weakened. Trade war tensions threaten global supply chains and the foundations of the post-World War II economic system. Consumers, businesses, and investors will all be susceptible to aggressive and retaliatory trade measures.

But the positives include a still-solid global economy; strong momentum in corporate-profits growth; and equity valuations that still appear reasonable against the backdrop of still-low, but rising, interest rates.

A broadening of the trade war with China or a U.S. departure from the NAFTA accord would likely have a severely negative impact on the profitability of U.S. manufacturers, prompting us to reassess our still-positive view. Additional tariffs could lead to inflation. Rising interest rates in order to counter a threat to price stability could aggravate any economic shocks and potentially bring on a bear market.
This is not our base-case scenario. We still think this old bull has some life left in it, but the risks to the equity market now seem more balanced than skewed to the bullish side. 

Index Definitions:

The MSCI Canada Index is designed to measure the performance of the large- and mid-cap segments of the Canada market. With 90 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in Canada.

MSCI Emerging Markets Index is a free float-adjusted market capitalization weighted index designed to measure the performance of global emerging market equities.

The MSCI EMU Index (European Economic and Monetary Union) captures large- and mid-cap representation across the 10 developed-market countries in the European monetary union (EMU). With 247 constituents, the Index covers approximately 85% of the free float-adjusted market capitalization of the EMU.

The MSCI Japan Total Return Index is designed to measure the performance of the large- and mid-cap stocks in Japan.

The MSCI United Kingdom Index is designed to measure the performance of the large- and mid-cap segments of the UK market. With 101 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in the UK. 

The MSCI USA Index is designed to measure the performance of the large- and mid-cap segments of the U.S. market. With 632 constituents, the Index covers approximately 85% of the free float-adjusted market capitalization in the U.S.

Legal Note

Disclosure:

This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice. This information is for educational purposes only.

There are risks involved with investing, including loss of principal. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Bonds and bond funds will decrease in value as interest rates rise. High yield bonds involve greater risks of default or downgrade and are more volatile than investment grade securities, due to the speculative nature of their investments.

Information provided by SEI Investments Management Corporation, a wholly owned subsidiary of SEI Investments Company. Neither SEI nor its subsidiaries is affiliated with your financial advisor.