Blog Posts — January 12, 2018

2018 Outlook II: Roaring Bull Faces Hurdles

After a bumper year for equities, strategists are forecasting further gains for 2018, while pointing to risks from rising bond yields and higher volatility.

The average of four brokerage forecasts1 compiled by PULSE ONLINE sees gains of 11% for European equities this year as the economy and corporate profits expand. That compares with a 6.6% gain for the EURO STOXX 50® Index and a 7.7% advance for the STOXX® EUROPE 600 in 2017.2

In the US, the average of five predictions3 calls for gains of 6.9%, a slowdown from last year’s 20% price return for the STOXX® USA 900 Index.

Ageing rally has legs

A majority of asset allocators and money managers are starting the year favoring equities over other asset classes, and Eurozone shares in particular.

While bank strategists are used to calling for positive markets, this year they are hedging their bets by pointing to headwinds for a bull market that is now eight years old. The principal challenge is the removal of accommodative monetary policy.

Eurozone and Japan to reach new highs

The STOXX® Global 1800 Index rose 23% in 2017,4 reaching a record high and posting its best year since 2013. The predicted gains for 2018 would lift the EURO STOXX 50® Index to its highest post-crisis level. A similar advance would help the STOXX® Japan 600 Index climb past its 2007 record to the highest since data starts in 2001.

Protection against an increase in volatility

Houses from Fidelity International5 to Deutsche Bank6 have warned that equity volatility is likely to increase this year, causing market pullbacks. It might be useful, then, to review some strategies that investors have at hand to protect portfolios from market retreats.

After years of being a drag on portfolio performance, cash may prove itself as a defensive strategy in times of market volatility. The STOXX Risk Control Indices replicate a portfolio that combines an underlying equity index and a cash component. A predefined risk level – determined by the volatility of the underlying index – acts as a trigger to raise or decrease the cash component.

Another strategy would be holding low-volatility stocks, which tend to resist market corrections relatively better than others.

Within the low volatility group, minimum variance strategies take into account the covariance among stocks and focus on the overall volatility of a portfolio rather than of its individual components. This helps to avoid the usual intra-stock correlation and sector concentration risk that results from investing individually in low-volatility stocks.

“The benefit of minimum variance strategies is that not only can investors reduce volatility, but data shows low-volatility stocks also produce excess returns in the long term,” says Dr. Jan-Carl Plagge, Head of Applied Research at STOXX Ltd. “These can be statistically significant.”

Finally, the EURO STOXX 50® Volatility Index, or VSTOXX®, may keep garnering new interest as a hedge against equity moves. Trading in derivatives tied to the VSTOXX, which tracks real-time options prices for the EURO STOXX 50, was poised to end 2017 with record volumes as more investors turn to the benchmark as a gauge of political and market risk in Europe.

Winners in sectors: banks and technology

As for rising yields, strategists including JPMorgan’s Mislav Matejka7 say there is a sector that stands to benefit directly from higher interest rates: banks.

The changing monetary landscape would prove a tailwind for an industry that’s underperformed in the aftermath of the global financial crisis, amid low interest rates and stricter capital rules. The EURO STOXX® Banks index has risen 75% since March 2009, around half the 145% advance for the benchmark EURO STOXX 50.

Will the tech boom prove durable?

Technology was the steadfast locomotive of equity gains in 2017 and money managers including UBS Wealth Management say the sector’s momentum may continue.8

UBS expects gains for the US technology sector given its projected 2018 earnings growth of between 12% and 13%. The firm’s strategists say that while technology stocks trade at a 7.5% premium to the market, the sector’s 25-year premium average has been 22%.

The STOXX Global 1800 Technology index rose 38% in 2017, excluding dividends.

Our 2018 outlook series will in coming articles look into the increasingly popular topics of thematic, infrastructure and sustainability investing, as well as into factor-investing approaches. All of them may continue to garner attention in the new year.

Featured Indices

1 JPMorgan, Citigroup, UBS and Deutsche Bank.
2 Price return, EUR.
3 Goldman Sachs, Citigroup, UBS, Credit Suisse and Bank of America.
4 Price return, USD.
5 Fidelity, ‘CIO Outlook 2018,’ Dec. 5, 2017.
6 Deutsche Bank Research, ‘European Equity Strategy,’ Nov. 15, 2017.
7 JPMorgan Cazenove, ‘Equity Strategy,’ Dec. 4, 2017.
8 UBS House View, Europe Chief Investment Officer WM, ‘Year Ahead 2018.’