Many of our top risks for 2018 have come to pass.
Our updated top five global risks for investors in 2018 are: geopolitics, chasing returns, return of inflation, dollar strength, and fading momentum.
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.
In our Five Global Risks for Investors in 2018 published at the start of the year, we offered a list of the top five risks, that we are now updating:
- Chasing returns
- Return of inflation
- Dollar strength (replacing Private investment boom)
- Fading momentum (replacing Natural disasters)
At mid-year, it is a good time to review where these risks stand and see if any new risks make the top five. We’re dropping “private investment boom” and “natural disasters” from our top five, replacing them with “dollar strength” and “fading momentum”.
Geopolitics remains the top risk for investors this year.
As we noted at the beginning of the year, ahead of any tariff implementation or escalation of trade battles:
“Entering 2017 many investors were intensely focused on geopolitics after the Brexit vote and the U.S. election, but the acceleration in global growth outweighed any potentially negative impact from either trade disputes or military threats. The opposite could happen in 2018.”
The opposite has taken place: a slowdown in global growth combined with escalating trade conflicts weighed on stock market performance in the first half.
While geopolitics remains high on our list of risks, it is worth nothing that the threat of military conflict with North Korea, considered a big risk by many at the beginning of the year, de-escalated quickly. In fact, one year ago President Trump threatened North Korea with “fire and fury like the world has never seen.” In response, North Korea announced its plan to fire missiles at Guam. Ultimately, there was no military action and tensions 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.
2) Chasing returns
Chasing returns remains a consistently predictable investor behavior and a top risk for 2018.
As we had warned at the start of the year:
“In our 2017 outlook, we pointed to the turnaround in the five year return for global stocks as a clear signal of the rebound in net buying of equities that took place last year. In 2018, that trend may reverse.”
It has reversed, as forecasted by the slump in the five year rolling return for stocks.
Without the aid of advice and a financial plan, investors often tend to chase returns. The rolling five-year return has most closely mirrored investors’ buying and selling of stock funds (mutual funds and exchange-traded funds combined), as you can see in the chart below. Investors’ buying has faded this year 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, suggesting continued weakness.
Investors’ buying spree fading in 2018
Global stocks represented by MSCI AC World Index. Past performance is no guarantee of future results.
Source: Charles Schwab, Investment Company Institute, data as of 7/16/2018.
3) Inflation surprise
An inflation surprise that forces central banks to raise interest rates more quickly than expected remains a top risk.
Because risk is often hiding in plain sight, we cited complacency on inflation and the related policy moves that have historically ended many past economic and market cycles as a risk at the start of this year:
“Yet, few expect any uptick in inflation next year. The economist and market consensus is that inflation will remain the same as in 2017. In fact, to use the U.S. as an example, of the 74 economists tracked by Bloomberg only five expect even a half of a percentage point rise in inflation in 2018.”
Inflation has jumped in 2018 to a year-over-year pace of 2.9% after ending 2017 at 2.1%, as you can see in the chart below.
Inflation on the rise in 2018
Source: Charles Schwab, Bloomberg data as of 7/22/2018.
More of the world’s central banks are hiking rates in 2018 than at any other time in the past six years (for more on this see Schwab Market Perspective: What Happened to the Summer Doldrums?). This increases the risk of an inverted yield curve in the coming year, a historically reliable indicator of global recessions and bear markets.
4) Dollar strength
A sharp and sustained rise in the value of the U.S. dollar poses a risk to global investors in 2018.
The value of the U.S. dollar rose sharply beginning in April after falling steadily in 2017. A continued rise in the dollar could act as a drag on the dollar-based returns of non-U.S. investments. 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.
Sharp U.S. dollar rally in 2018
Source: Charles Schwab, Bloomberg data as of 7/20/2018.
5) Fading momentum
The fading global economic momentum this year was not unexpected, but could pose a risk to investors if deceleration continues and momentum fails to stabilize.
The economies of Europe and Japan are expected to slow this year to a more sustainable pace of growth after above average growth in 2017. China also continues to see its economic momentum fade. The pace of these slowdowns caught many economists by surprise in the first half of the year as the economic data widely missed economists’ expectations.
Based on the global composite purchasing managers index (PMI), a timely reading of economic conditions around the world, the economic deceleration appears to have stabilized. Reflecting steady and solid global growth for much of 2017, the global PMI jumped late in the year and then slowed sharply in early 2018, as you can see in the chart below. The global PMI has stabilized following the drop, but the risk of a renewed decline cannot be ruled out.
Global economic volatility has seen an uptick in 2018
Source: Charles Schwab, Bloomberg data as of 7/22/2018.
Downgraded risks from the top five
We noted at the beginning of the year that the chase for yield led “investors to increasingly turn to exploiting the spread between public and private assets, known as the liquidity premium, fueling a boom in private assets that aren’t traded in public markets such as private equity, private debt, commercial real estate, and direct lending.” We are downgrading this risk from the top five, given that there are few signs of a downturn in these assets that could spill over into publically traded stocks or bonds.
Natural disasters remain a concern, but it also no longer makes our top five. After 2017 ranked as the most costly year ever for natural disasters, we wrote that “an increasing wave of disasters may mean the repeated costs of rebuilding start to outweigh the boost to growth. That could lead to a change to the muted way markets have historically reacted to disasters.” While 2018 has also seen its share of tragic natural disasters and the Atlantic hurricane season is not yet underway, it appears that 2018 may not repeat 2017’s devastation.
It’s best to close with a reminder of two key takeaways from the beginning of the year that still hold true in our estimation:
“A global recession would be a big risk for stocks. 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.”
“Whether or not these particular surprises come to pass, a new year almost always brings surprises of one form or another. 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.”