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What Bubbles Will Pop In 2018?

This article is more than 6 years old.

Quick answer: none. So says just about everyone minus the perennial bears out there.

Okay, maybe bitcoin loses 75%.

Another year, another record breaker. Contrarians can't cut a break. Chinese hard landing aficionados...lose again. Bitcoin was supposed to crash once Beijing and Seoul banned their exchanges and/or initial coin offerings, instead, it fell for about a month and then rose over 300%. In March, the 10 year Treasury yielded 2.6%. It now yields 2.3%, meaning more money is pouring into government bonds even though everybody and their mother knows that the Fed is going to hike by around 75 basis points next year (three, not four). Interest rates will be even higher. So what? Investors are still buying bonds at a premium, locking in a lower yield than they can get in just a few short months from now assuming bond prices at par.

The European Central Bank (ECB) will announce its taper plans on Thursday. The ECB is already spending (or perhaps wasting) less money buying toxic debt with almost no yield. Next year, they will spend even less. If all goes bad, the bond market will implode and European banks will be in trouble. If all goes horribly wrong, maybe a major bank will go belly up. (Not Deutsche Bank. It's Germany's Goldman Sachs and JP Morgan. It gets saved.)

Everything about bubble poppings is based on investor memories of 2008-09. People are trying to forecast the fallout, a fallout some consider will be massive when it comes. If it comes. It won't come this week from the European Central Bank.

"The European Central bank is likely to sound less dovish on Thursday while the market is largely expecting that the bank would be rather dovish with its approach," says Naeem Aslam, a chief market analyst for ThinkMarkets in London. He thinks the euro gains against the dollar heading into 2018. "The euro is without a doubt the best performer among major currencies this year and a surprise by the ECB could make for a very Merry Christmas for the euro bulls. The euro has the potential to move well above the 1.20 mark in 2019 because the market hasn’t priced in the prospects of the ECB actually increasing interest rates."

Face it, the bulls are killing it. The bears can't growl loud enough above this stampede and next year, barring a surprising war, or perhaps an impeachment of President Trump if the Democrats win both houses in the mid-terms, it's status quo for the U.S. economy with some minor upside, and major upside for beat down markets like Brazil.

Potential Bubble Popping Triggers

How will markets react to rising rates in the U.S. and Europe? What happens when the ECB shuts down the life support system it runs for the European bond market?

"Investors may well ask whether these problems have been deferred or whether markets will again take them in their stride," says Peter Harrison, CEO of Schroders, a London-based global money manager. "One area of the equity market likely to stand out is value. After the longest period of underperformance in over 40 years, the catalyst for a turnaround could be a rise in inflation and therefore interest rates. Assuming policymakers can successfully juggle sustaining the recovery by controlling inflation, global bonds should not experience much downside," he thinks.

No bubble popping in bonds, Schroders calls it.

Janus Henderson

No bubble popping in U.S. equities either. Janus Henderson makes the call.

"The options market does not believe that the equity market has to self-correct just because we’re a decade into the expansion, while the average business cycle lasts six years. We’re in the camp that this expansion can continue," says Ashwin Alankar, head of global asset allocation and risk management for Janus Henderson.

Janus Henderson

Although this is a rear-view look, Morningstar analyst Janet Yang said that not one of the 200 funds they reviewed in the month of November got a downgrade by their North American and global ratings committees. They reaffirmed positive views on 125 funds, upgraded 10 funds, and put seven funds under review. Yang called it "an unusual month" because not a single fund was downgraded.

There are trigger warnings, depending on how you look at the market. Technical warnings include high valuation and relative strength, but each time the big index ETFs bust through 70 RSI on a chart, there's a quick sell-off of maybe 5% to 10%, and it comes right back again.

Consensus is that the big central banks of Japan, U.K., Europe and the U.S. will be prudent.

Bitcoin might pop and go from $16,000 to $8,000 or less. But making that call is as easy as saying it will go to $50,000 or higher. More companies are allowing for bitcoin payments, meaning this is becoming a real currency. Other smaller cryptocurrencies that do not get the press like bitcoin, ether, and litecoin, may vanish from the scenes, but these are puny in comparison to the big three. They are akin to watching a few unprofitable startups no one has heard of go to dust.

No one is listening to the China hard landing story anymore. It is over. There are credit concerns and housing concerns, but China is not a full market economy. The People's Bank of China has more money in reserves than the entire GDP of Brazil. If it wants, or needs, to throw money at a problem it can do so. If it wants to curb capital flight, it will. These are variables that many in the market discount, often treating the No. 2 economy as if it is as transparent as the E.U.

Mexico is at risk because of politics. Brazil too. Russia is coming back alive, and the collusion story seems to be falling apart. This could change sentiment on Russia next year, even as Vladimir Putin is expected to win the presidency for the fourth (and final) time.

Big picture geopolitical risks that may affect asset allocation are mostly tied to Trump trade talks with Mexico, Canada and China; North Korea going ballistic; and Saudi Arabia escalating its fight with Iran.

In the meantime, emerging market stocks and bonds are expected to be an outperformer again next year.

Alex Wolf, senior emerging markets economists with Aberdeen Standard Investments says strong external demand and improving domestic demand will help countries like India, which seems to be his favorite within the BRICS. "We are in line with the consensus for 2018 Indian growth at 7%, but slightly below consensus on China expecting 6.2% growth in 2018," he says.

Contrarians waiting for drama and a return of high volatility may be disappointed.  The Fed can deliver the three hikes in 2018 and still have a sizeable majority in favor of gradually higher rates for 2019 if the inflation call is right. The market has not been shocked at all by the Fed raising rates three times this year as told, even though many doubted forward guidance by the central bank and to get just one.  It is unlikely the market will be shocked by a re-occurrence of three hikes next year. However, any surprise by the Fed, ECB, BoE or BoJ on this front would be viewed as both a shock and a philosophical change, warns David Bloom, head of forex research at HSBC Bank in London.

Such a move would come with "with immense implications for currencies and the low volatility world we are now living in," he says.

There's a trigger warning, right there.

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