2017 has been a stellar year for investment portfolios - especially those which have a good exposure to equities. Additionally, many New Zealand house prices have nudged higher and we have seen slightly higher rates for term deposits. Nothing is guaranteed but there are no major dark clouds looming on the horizon over the next few months that would indicate a major correction in the financial markets.
However, market volatility is increasing and it is inevitable that financial markets will need to take a breather sometime later in 2018. Market risks are rising due to:
- Accelerating growth: It is likely economic growth will increase slightly in 2018 and this will be further fuelled in NZ by an already tight labour market where growing businesses are competing for good talent. This leads to inflation and a potential rising of interest rates in NZ later in 2018. The USA has already started to raise interest rates.
- Huge accumulation of debt: Many countries and households around the world are burdened with massive debt levels. Rising interest rates make this debt even less affordable than at present. Many will struggle with the requirement to meet interest payments and repay capital. Banks will need to monitor this carefully.
- Volatility from the political backdrop: New Zealand has a new government that intends to increase spending, reverse a number of policies of the previous government, and implement a fair degree of change. The actions of President Trump tend to create a degree of uncertainty. Brexit will continue to hang over the UK and Europe, plus China needs to implement increased financial regulation and purge excess capacity from the industrial sector. All these issues could potentially rattle financial markets.
- Timing the end of the equity bull market: Commentators expect the equity bull market to continue a little longer. However, it has been running hot for many years and equity prices are starting to look expensive in many countries. Eventually, equity prices need to readjust to their longer-term trend line. Generally, a sustained fall in equity markets is usually associated with recessions. The good news is commentators are not expecting a recession for at least another 12 months as we still have reasonable economic growth, strong corporate earnings, low inflation and accommodative monetary policy.