A bumpy ride for investors in 2018

MANAMA: In the wake of an astonishingly calm 2017, Saxo Bank’s strategy team sees a market full of potential hazards as we head into the first quarter of 2018 and beyond. From central bank policy normalisation to rising inflation expectations, from fiscal deficit expansions to cross-asset correlations, the signs are all there.

Saxo’s Q1 Outlook covers the bank’s main asset classes: FX, equities, commodities, bonds as well as a range of central macro themes.

“The chase for yield continues while central bank policymakers, supported by politicians’ continued inability to pass real reforms, close their eyes and hope for the best. As we move into 2018’s first quarter, the world is again full of hope and precious little reality,” Steen Jakobsen, Chief Economist and CIO, Saxo Bank, said.

“The crypto bubble may be the most visible due to the high volatility and performance seen in 2017 but don’t be fooled into believing that other assets are not in bubble territory as well. In fact, the length and extent of some bull markets may conceal just how far from fundamentals these assets have drifted.”

“We do not claim to know when the current bubbles will burst. We can, however, identify where they exist and in our view there are a great many bubbles afoot right now. We see them in the bond market, in equities, in private equity, venture capital, real estate and certainly in cryptocurrencies. (Interestingly enough, we see no bubbles whatsoever in commodities.”

The year 2018 will be a make-or-break year for the burgeoning crypto asset market. The optimists are looking for the market cap to top $1 trillion while pessimists foresee increased regulation and even the outright banning of cryptocurrencies as monetary authorities decide that the space is out of control.

“Crypto assets are behaving like the dot-com stocks of the late 1990s. We expect more companies to announce blockchain pivots before this speculative phase is over. Q1’18 will see more projects hitting the market, each touting itself as the next crypto revolution in its particular sector. This, again, will only drive further speculation in this nascent market,” Jacob Pouncey, Cryptocurrency Analyst, said.

“If the crypto space is to see a new leader; Ethereum seems to be one of the assets with real-world utility that goes beyond its standard function. It is now processing over 1.25 million transactions/day and tens of billions of dollars in volume.”

More than a simple metaphor, a bubble is a distinct mathematical form in which super-exponential growth causes a departure from fundamentals and an eventual sharp correction. Of all concepts to keep front-of-mind into 2018, this may be one of the most crucial.

“When considering a rapidly rising stock such as Amazon, the log-price corresponds to a straight line. This indicates an exponential price rise which is fast, but not extraordinary. In contrast, the price of a Bitcoin has continued to grow even faster every year since 2015 in a super-exponential fashion. In the presence of a bubble, the risk of a crash or at least a major correction is significantly increased. Theories have been proposed for when and how bubbles evolve and burst, but in the end, nothing is certain until after the pop,” Anders Nysteen, Quantitative Analyst, added.

With strong momentum from an extraordinary risk-taking year in 2017, this year should prove to be dynamic, with many subplots and increased volatility.

“Looking ahead, we see clear “known knowns” that are quite likely to disrupt the one-way complacency of 2017 at some point in 2018, whether already in Q1 or not until the second half of the year,” John Hardy, Head of FX Strategy, said.

“A number of leading inflation indicators point to the risk of a strong pickup in inflation already in the first half of 2018. The US budget deficit widened in 2017 for a second consecutive year and should widen aggressively in 2018 as a result of the funding shortfalls from President Donald Trump’s rushed tax reform policy. With a possible deficit of $1 trillion for 2018 looming, who will step in to finance when global FX reserves are not building as they have in the past?”

“EM and riskier currencies could enjoy some further upside on the global growth upswing story but gathering headwinds will arrive if volatility picks up notably, which is one of our base assumptions. The only perceived path to a surge of strength in the greenback is if some sort of real liquidity crisis develops at some point – the perennial fat-tail risk. That risk may only materialise if we see the much-discussed global market melt-up risk unfolding first.”

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