In early January, Schwab’s Chief Global Investment Strategist Jeff Kleintop published an outlook on the global economy and identified what we saw as the five biggest risks for investors. Now we’re revisiting our outlook. Three risks remain, and two—natural disasters and a boom in private investment—have been replaced by a strong dollar and fading economic momentum.
1. Dollar strength (new)
After steadily falling in 2017 and hitting a recent low in February, the dollar has rallied. Schwab now views the sharp and sustained rise in the value of the U.S. dollar as a notable risk to global investors in the remainder of the year. “A continued rise in the dollar could act as a drag on the dollar-based returns of non-U.S. investments,” Jeff explains. “It may also escalate trade tensions if other countries are seen as weakening their currencies to win a trade advantage against U.S.-based competitors.” A result could be tighter global financial conditions, contributing to slow growth and financial stresses.
2. Fading momentum (new)
Schwab believes that the fading global economic momentum we’ve seen this year could pose a risk to investors if deceleration continues and momentum fails to stabilize. China’s economic momentum has waned, and both Europe and Japan are expecting economic growth to slow; during the first half of 2018, the pace of these slowdowns caught many economists by surprise, as economic data widely missed economists’ expectations.
The global composite purchasing managers index (PMI) offers a timely reading of economic conditions around the world; it currently shows that the economic deceleration appears to have stabilized, after having fallen sharply in early 2018. However, as Jeff reminds us, “the risk of a renewed decline cannot be ruled out.”
Geopolitics still ranks among our top five risks. As opposed to last year, when accelerating global growth outweighed potential negative impacts of trade disputes or military threats, the opposite has taken place in 2018. As Jeff explains, “A slowdown in global growth combined with escalating trade conflicts weighed on stock market performance in the first half.”
“It is worth noting,” he continues, “that the threat of military conflict with North Korea, considered a big risk by many at the beginning of the year, de-escalated quickly, and tensions have cooled. In a similar way, the second half of the year might see a de-escalation of trade conflicts as world leaders negotiate away from a potential trade war.”
4. Chasing returns
As Jeff noted in January, “consistently predicting what markets will do is hard, if not impossible; but predicting investor behavior can be surprisingly simple: Without the aid of advice, investors often tend to chase returns.”
The global stock market’s rolling five-year return has most closely mirrored investors’ buying and selling of stock funds (mutual funds and exchange-traded funds combined). In 2017, the rebound in net buying of equities followed that signal. Now the trend has reversed, as forecasted by the slump in that five-year rolling return indicator. “Investors’ buying has faded this year,” Jeff observes, “and the five-year rolling return for the stock market is likely to continue to fall as it rolls off the strong returns in the second half of 2013.”
5. Inflation surprise
Last, an inflation surprise that forces central banks to raise interest rates more quickly than expected also remains a top risk. Investors and economists alike may be getting too complacent about inflation and the related policy moves that have historically ended many economic and market cycles.
In fact, after ending 2017 at 2.1%, inflation has jumped to a year-over-year pace of 2.9%. “More of the world’s central banks are hiking rates in 2018 than at any other time in the past six years,” Jeff says. “This increases the risk of an inverted yield curve in the coming year, a historically reliable indicator of global recessions and bear markets.”
“A global recession would be a big risk for stocks,” he concludes. “While the global economic cycle is aging, we don’t foresee a global recession taking place in 2018—although that risk may rise in 2019.”
One takeaway that always applies, no matter what the outlook: Be prepared. As Jeff reminds us, “Having a well-balanced, diversified portfolio and being prepared with a plan in the event of an unexpected outcome is a key to successful investing.”