Every July, adrenaline junkies from around the world converge in Pamplona, Spain for the Fiesta de San Fermin—the highlight of which is the running of the bulls. These controversial and, at times, dangerous races pit the bravery, dexterity, and wits of the runners against the momentum of the crowd and the speed of the bulls. This scenario is very similar to what we’re anticipating will play out in the markets in 2018. The skill, experience, and smarts of investors are going to be challenged by the momentum of the markets, which is why Russell Investments has called our 2018 Global Market Outlook “Running with the bulls.”
We are currently in the second-longest running bull market on record, and several market forces are already conspiring to fulfill the prophecy that bull markets typically die in euphoria, or are killed by a policy mistake. So, what does this mean for nonprofit fiduciaries?
2018 will be a year of two halves
In the first half of the year, we expect to see a continuation of the momentum in the markets, which has produced solid returns during the recovery. In the second half of the year, we may see markets begin to slow. Our models put the probability of recession in the next 12 months at around 25 percent, which is a new high for this ten-year economic expansion. It’s not time to be alarmed yet, but caution is advised given the age of the expansion. Overall, we think the U.S. economy is still on a path of moderate growth with low probability of recession over the next year. But, risks are building at the three-year horizon. We are recommending that you pursue strategies that balance longer term recession risks with shorter term opportunistic strategies. These shorter-term strategies could include moves such as increasing your allocation to assets like emerging market bonds, and reducing your allocation to assets such as growth-oriented global equity. Making these adjustments now can allow you to participate in the upside if markets continue to run, and can protect you on the downside if a sharp sell-off occurs.
Global monetary policy is anticipated to deliver lower returns on government bonds
Because rising interest rates impact the returns on long-term investments, we believe it is vital for you and your provider to manage interest-rate volatility across your portfolio, not just within your fixed income allocation. For example, in our multi-asset portfolios, we maintain underweight positions to interest-rate-sensitive asset classes such as listed real estate and listed infrastructure in light of their higher-than-average leverage levels. At the same time, we are maintaining overweight positions to the financial sector, which tends to benefit from higher interest rates.
U.S. equities are approaching bubble territory
U.S. equities are at an all-time high; in fact, they’re at their most expensive level ever outside of 1929 and the late 1990s. We believe U.S. equities can climb higher over the first half of the year with the short-term boost of tax reform, before facing headwinds in the second half as markets factor in rising recession risks. To protect against this, investors should begin to tilt away from U.S. equities in favor of non-U.S. exposures, particularly in Europe, Japan, and, to a lesser degree, emerging markets equities. We recommend—if you haven’t already—working with your provider to diversify into these regions, as extremely expensive U.S. equities make the domestic market vulnerable to unwelcome news.
For many nonprofits, these shifts signal an environment where achieving CPI+5% is going to be difficult to achieve over the coming three to five years. We encourage you to get these items on your investment committee meeting agendas in the first quarter of this year so you have ample time to take steps to protect your portfolio for the market changes to come.
To see Russell Investments’ full 2018 Global Market outlook, click here.
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