It feels like we’ve spent much of 2017 waiting for the punchline to 2016. But, to paraphrase John Lennon, life is what happens while you – or your governments – are busy making other plans. Companies have remained active, the global economy has grown faster and markets have been buoyant in 2017 – whatever the uncertainties. With this in mind, I’ve picked my five biggest themes of 2017 with some thoughts on what comes next. Spoilers – it might not be more of the same.
Our 2017 word cloud…
Way back in January, we predicted the world would be unpredictable, partisan, growing (selectively), inflating, monetarily tighter, more interventionist, less unfamiliar, bold-in M&A but more stressed in places. Not bad – and it brings me to my first theme….
1. Predictably unpredictable
Was 2017 actually that hard to predict? It was certainly full of uncertainty, although how much is hard to measure. The Economic Policy Uncertainty Index below uses press articles, which is arguably has limitations given the way the media reflects, but also amplifies concerns. Although, I’m not sure I need any index to tell me that 2017 was a policy and geopolitical roller-coaster. From the unexpected UK general election, through Brexit negotiations to US tax reform, we’ve been on policy tenterhooks and some days it was a relief just to wake up in the morning.
But did that uncertainty make a difference?
I’m not sure it did. Just look at the way ‘uncertainty’ nestles against ‘growth’ in our 2017 word cloud. The synchronised uptick in growth we saw across almost all major economies in 2017 and the promise of US tax reform have been powerful elixir – especially for equity markets.
3. Inescapable disruption
Our word cloud also highlights M&A’s prominence in 2017, with companies seemingly undaunted by uncertainty – a sea change from previous eras. That includes PE too. The digital revolution has been a big part of deals carrying on regardless. Indeed, we’re arguably at the point now where digital isn’t disruptive, it’s just the norm. Digital threads wind through the major deals of the last week, from shopping centre to media consolidation. In 2017, we’ve also seen a record number of transactions where non-technology companies have bought tech companies. The value of these deals has fallen compared to 2016, but volumes are up which reflects the fact that more small-to-medium companies are getting in on the act. This isn’t just about the big guys any more. Add in Amazon buying Whole Foods – a major move the other way – and I think we can say that convergence came of age in 2017.
Digital isn’t the only deal driver going into 2018. We’ve discussed here how Brexit is shaping deal activity. We’re still waiting on US tax reform. But even if this doesn’t happen – or the uncertainty stalls deals for a while – the incentive to transact still looks pretty strong in 2018. Mega- deals may fall off, but the need to reshape businesses should keep volumes strong. We’re also changing the way we transact and do deals, with major cyber security breaches increasing the importance of cyber diligence, for instance.
3. Marvellous markets?
We spent much of 2017 marvelling at markets, from the height of equity valuations to the lowness of yields and the overall lack of volatility. Half of the 35 major indexes representing world’s biggest stock markets by value have hit all-time highs this year, the most since 2007. European high-yield indices have hit all-time lows. European companies have been able to sell debt in record amounts. The increase in activist and LBO activity could see this pick up further in 2018.
Global economic and earnings growth provides a foundation to the equity rally -especially across the Eurozone. But, for the equity market marvel to be maintained, we’ll need to see a continuing policy progress – especially in the US – alongside improving investment and productivity, which have remained frustrating low in this recovery. Monetary tightening could pause if growth slows, but central banks need a buffer for the next downturn and an extended period of loose policy and low yields are encouraging investors into riskier areas. This all leaves little room for error and some doubt as to how long this Goldilocks period of warm growth and cool inflation that has kept both equity and bond prices high will last. High-yield debt remains our canary going into 2018.
4. Difficult Divergences
Brexit is unsurprisingly dominant in the 2017 cloud in another partisan and vote dominated year. It’s impossible to say if domestic politics have put us on the path to a towards a soft or hard Brexit – it might all change next week – and there are 27 other nations involved, each with global and local issues demanding their attention. Add in the impact of the weak pound on inflation and disposable income and we get a UK economy that’s still growing, but diverging from the improving picture elsewhere. The hit to disposable income, in combination with rising costs and structural changes has created renewed stress within retail – including car retail and other consumer sectors – notably restaurants – sectors we’ve covered in depth this year. I expect 2018 to be the toughest year since the financial crisis for sectors exposed to the consumer.
5. Turning point?
So, whilst in many ways 2017 felt a lot like 2016, we saw some big changes that will feed through into 2018. On balance, the global economic outlook is better, but the risks are also undiminished and the UK’s outlook is diminished and diverging. Tighter capacity threatens the Goldilocks market consensus. In many ways, 2018 could be tougher for companies. The US yield curve is certainly signalling trouble, but there’s some doubt as to whether we can still trust this measure. So, just for fun, for my last thought of 2017 I’m going to look elsewhere for clues.
H/T to the FT for this chart from Pictet Wealth Management’s US economist Thomas Costerg. Pleasure boat buying, a key ‘discretionary’ purchase, tends to accelerate in the later phases of the business cycle and there has been a sharp pick up in boat buying in recent months. Tax reforms might keep this going in early 2018; but, by this measure, we may be approaching ‘peak boat’ and the peak of the business cycle.
That’s all from me for 2017. I hope you all enjoy the holidays and look forward to talking again in 2018.