The three risks investors need to keep an eye on

What are the three main areas of concern for investors as we head into the third quarter of the year?

As we enter the third quarter of 2018, there are three main areas of concern for investors, according to JPMorgan Asset Management’s latest quarterly Guide to the Markets.

The first: how long can the US economic expansion last?

Ten years on from the financial crisis, and the US economy is going strong. Consumer confidence is near cycle highs, while manufacturing (measured by the ISM Manufacturing survey) is in the midst of a boom. At the same time, unemployment is at its lowest point since 1969. All this has seen the US economy record its second longest period of expansion on record.

And the growth is set to last for a while longer. According to Nandini Ramakrishnan, global market strategist at JPMorgan: ‘As reduced tax rates and higher government spending come into effect, US growth is forecast to be robust for 2018 and 2019.’

This sentiment is echoed by investor surveys. According to a Bank of America Merrill Lynch survey from June, the majority of investors surveyed do not think the US will enter recession until at least 2020, though a sizeable minority expect growth to end towards the end of 2019.

At the same time, buoyant oil prices should further benefit the US economy: ‘the recent increase in the oil price is reinvigorating the energy sector,’ says Ramakrishnan.

All this has been good for US equities, with earnings per share growth forecast at 20 per cent. However, warns Ramakrishnan, ‘investors would be wise to monitor how long the party can last. This level of growth is much higher than the recent trend. Without a recovery in productivity, gravity will pull US growth towards 2 per cent.’

At the same time, continued low unemployment levels are likely to create wage pressures. While they’re good for US workers, higher wages will soon erode corporate profits, which will make itself felt in US equities.

Europe: still a disappointment?

The picture in Europe is more mixed. Tipped as being on the cusp of economic take-off at the end of 2017, the continent has so far proved a disappointment this year, with economic data generally coming in below expectations.

However, argues Mike Bell, global market strategist at JPMorgan, with expectations now low, equities could soon start to recover. ‘The Eurozone Citi Economic Surprise index looks to have bottomed recently. Historically, a rebound in the Surprise index off low levels has tended to coincide with positive returns for eurozone equities over the coming six months,’ notes Bell.

As the chart below shows, Europe’s economic slowdown appears already to have been priced into equity markets.



However, political risk remains a concern for the region. While the likelihood of Italy leaving the European Union remains low, ‘a confrontational Italian government could still prove a source of volatility,’ says Bell. At the same time, Europe remains vulnerable to US auto tariffs.

Politics in command

Indeed, political risk in general remains a key concern for the world economy in the third quarter of 2018.

First of all, there is the risk of an escalation in the US’s trade dispute with China and Europe. In a bid to close its current account deficit, the US has introduced a number of tariffs on goods entering the US. So far, that has had little impact on global equities.

The key question, however, is whether or not the dispute escalates. According to Karen Ward, chief market strategist for EMEA at JPMorgan, ‘this depends on how these policies are received domestically as the midterm elections approach.

‘It is unclear at this stage whether the US administration has a political incentive to dial it up or dial it down before voters go to the ballot box. This uncertainty alone argues for a more cautious approach to risk until the outlook is clearer.’

The other key political risk is the conclusion of the Brexit negotiations. According to Ward, ‘by the end of the year, if not the 18/19 October EU summit, we expect the heads of terms of a Brexit deal to be agreed – one that preserves trade in both goods and services.’

If such a deal is agreed upon, ‘there could be considerable implications for UK markets.’

Sterling should see a strong recovery, which at the same time should lower inflation. At a time of real rising wages, this should improve the outlook for UK consumers considerably.

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