A synchronized global expansion has room to run in 2018. Strong corporate earnings and steady growth support our belief that investors will get compensated for risk-taking in equities, particularly outside the U.S. But 2017 will be a tough act to follow. Geopolitical risks, inflation and other factors could make the road ahead more challenging.
Room to run
We believe markets are underestimating the durability of the economic expansion. Many investors fear the end of the market cycle is near, as the gap between potential and actual GDP is shrinking in the U.S. Yet economies can run beyond potential for a long time before peaking.
We see inflation in the U.S. rising back to a 2% target – a turnaround from fears of near-zero inflation or even deflation two years ago. The Fed looks poised to press ahead and deliver three 0.25% rate increases in 2018. In Europe, however, we share the European Central Bank’s view that inflation may be stuck below target through 2019.
Reduced reward for risk
Valuations of risk assets have risen, market volatility has stayed low, and many perceived risks have not materialized – making markets more vulnerable to temporary sell-offs. While we don’t see any major risks triggering a sustained higher-volatility regime, this is precisely when fixed income as a risk management tool is critical.
BlackRock Investment Institute, December, 2017.