Equity valuations above historical averages in most developed markets do not necessarily mean that global equities are overvalued. Equity risk premiums in many markets still appear reasonable.
By Rob Sharps and Justin Thomson
We expect the waves of disruptive change in global equity markets to accelerate, fed by a powerful combination of technological innovation, changing consumer preferences, and evolving business models. These forces are upsetting the competitive balance in existing industries while at the same time spurring rapid growth for new products and services.
These trends continue to benefit a relatively small group of mega-cap companies that have created dominant positions in industries such as e-commerce, social media, mobile devices, and internet search. Competitive advantages have allowed these companies to leverage powerful economies of scale, sustaining rates of growth that – for their current size – are almost unprecedented.
We believe opportunities for profitable growth – both organic and through acquisitions – will remain plentiful for the technology giants in 2018. However, looking ahead, we see two key trends to watch:
For the first time since the 2008–2009 financial crisis, the global economy has entered a synchronized expansion. Strong growth, ample liquidity, and low inflation have produced an extended period of exceptionally low volatility – not just in equity markets, but in credit and currency markets as well. Whether this period of calm continues in 2018 remains to be seen, but we don’t view it as a sign that a correction is near.
Although valuations are above historical averages in most developed markets, in the context of low interest rates and low inflation shares do not appear overvalued. In addition, central bank policies appear constructive for equities. However, we remain mindful of the risk of inflationary surprises.
To a large extent, equity strength in 2017 has reflected broad-based economic growth. Barring unpredictable political or economic shocks, the global earnings recovery should continue in 2018, but perhaps not at the same rate. Key to markets weathering any slowing momentum will be investors retaining a perception that growth will remain positive as the economic cycle continues to mature.
Meaningful US corporate tax cuts could spur capital spending and hiring, potentially giving a second wind to earnings growth. More highly taxed US small caps could benefit disproportionately.
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