Year Ahead 2018

1. Looking back to 2017

In my previous ‘year ahead’ briefing the key question related to our current situation among the business cycle. This year did not provided a clear answer for that. In 2017 the global investment universe became more extreme from different perspectives.
So far global equites had a strong year beating all the other asset classes, while the volatility measures reflect limited risk averness. Can we consider these as signs of general market euphoria (which is usually followed by share price decreases)?


Historical performance of MSCI World index (source: Yahoo Finance)

CE4E9932-0055-458D-A697-E837057F61C5Current value of VIX index is close to its 3-year minimum (source: Yahoo Finance)

The S&P500 index achieved positive returns in each months of the year (after dividend adjustments) which is a clear historical record. The daily prices oscillated within extremely small daily ranges (more than 1% daily movements occured on a few trading days only).

We experienced 5-year record global growth rates with record high set of growth indicators, and the interest rate levels are still low. The global monetary thightening is ahead of us, the short-term Eurozone rates are still in negative territory, while the short end of the US yield curve is at appr. 2%.

C9E06416-5BEC-417B-8181-7A5AB34B214AComparison of US and Eurozone yield curves (sources: US Treasury, ECB; values are in percentages)

The growth stocks were clearly overperforming the value category. Technology, artificial intelligence stocks benefited from the general market hype and were characterised by extreme valuations (even in case of no proven revenue streams of early phase business models). A good example is Long Island Iced Tea which recently changed its name to Long Island Blockchain and the announcement caused several hundred percentages increase in share price on one trading day (link).
On the FX side, despite its clear interest advantage, the USD underperformed against several key currencies, resulting in one of the biggest surprise of 2018 from market perspective.



2. Expectations for 2018

Following several years of cumulative growth gains of the economy, the key question for us is whether there is still some room for the market to grow. The brief answer is yes in general, however the momentum of 2017 may not be repeated and there are signs of certain risk factors which underlines the necessity of strict position limits and risk management approaches.

OECD expects the global economy to grow by 3.7% in 2018 and the 2018 and 2019 forecasts show decreasing rates which can predict a kind of slowdown in mid term.

In absolute terms there is no really favourable asset class, the valuations are at record high levels. Due to the extremely low interest rates, the present and future values of expected cash flows are close to each other practically in every segment.

2.1 Equities

Despite the negative voices (duration of the current US cycle, euphoria on the markets, geopolitics, outlook of the Chinese economy, flattened yield curve), it seems that there is no real alternative of equities for the next year.
The high P/E ratios reflect a reasonable outcome of a low interest rate environment and as long as they are combined with low inflation stock market gains can be expected.


2.1.1 Regional preferences

The European equity sector – which was lagging behind the US in recovery from the recession – can easily be a top performer in 2018 due to the following considerations: (i) compared to all the other key regions (especially US and the emerging markets) the European stock market P/E ratios didn’t increase that much during the recent years, (ii) the Eurozone unemployment rate is already below its long-term average (which is supportive for consumption), (iii) increasing loan growth rates (with still favourable interest rate environment), (iv) high share of value stocks which sector might perform well in case higher yields will be realized.
The second preference is Japan where the central bank is expected to maintain the loose monetary policy to meet its inflation target. While the ECB, the FED and the other central banks seem to decrease the magnitude of their monetary stimulus, this can be a relative advantage for the Japanese stock market. This policy can result in a weaker JPN which is usually supportive for the equities due to the traditional negative correlation effect. Moreover, the traditionally non-leveraged Japanese corporate sector can benefit from any increase in their debt levels on their exremely low rate regime.
The UK market is not preferred now. As per OECD estimates, the growth rate of UK (1.2%) is appr. half of the Eurozone forecast (2.1%). The lack of clarity about the outcome of the Brexit situation may not go away anytime soon. Therefore it seems to remain as a drag on the UK market confidence. In addition, UK is among markets which are characterised by high number of dividend payers, and in case of increasing bond yields, these companies are underperformers.
No clear opinion on the direction of the US and emerging markets equity sector due to the sharp increase in their valuations.

2.1.2 Sectoral themes

In case of increases in bond yields, the financial sector is clearly preferred, based on historical data there is significant correlation between the long-term yields and the returns of this sector. On the other hand, the defensives are usually underperforming in such an environment.


Comparison of relative performance of European Financials (lhs) and the Eurozone long-term bond yields in % (rhs), source: Yahoo Finance

For mid term, I expect that the corporate digitalization solutions and electric car related equities can remain interesting for investors. According to McKinsey the development of the global IoT (Internet of Things) can result in an annual economic impact amounting to between USD 4 and 11 trillion by 2025; and the industrial/corporate sector could gain the biggest share out of that value.

Which sub-sectors can be the beneficiaries?

  • regarding the increase in EV penetration: utilities already announced related strategies (for example E.ON, Enel), miners/traders supplying key ingredients of battery manufacturing (for example Glencore – supplying close to 30% of global cobalt volume), car manufacturers (BMW, Volvo, VW), technology providers (for example Infineon)
  • regarding digitalization: software/platform developers allocating significant efforts on corporate/industrial digitalization and AI (for example SAP, Siemens, Google, Microsoft, Dassault), cyber security specialists and strategic consultants (for example Accenture)

Even on short term one of the key challenges for the corporate sector is the rapidly growing wage inflation. On this basis subsectors having large exposure to labor costs are not preferred.


2.2 FX


The mainstream opinion is shared in relation to the expected development of key currencies. In case ECB’s monetary policy will be stricter the EUR will appreciate against the USD and other currencies. The sterling is expected to underperform due to Brexit issues as mentioned previously. Weaker JPY is projected.


2.3 Bonds

It is definitely not the preferred asset class in case of increasing reference yields and stricter policy. On the other hand, individual stories might be available. One of them can be that the repurchase of own subordinated bonds by European banks to comply with the relevant Basel regulations (in case of ‘must have’ purchases, relatively high gains might be in place for investors).


Thanks for reading my thoughts. Wishing a healthy and successful year for everybody.



Arbitrage stories from a freshly liberalized market

What was the most important difference from investor’s point of view between our current age and the 1980’s and early 1990’s? Clearly the available level and quality of information. And if it is limited in general and not available to everyone in the same quality, this might trigger short term arbitrage opportunities. Especially in a country where first attributes of modern capital markets were just introduced. This post focuses on four colorful examples from different financial segments of a freshly liberalized economy, Hungary which stories could serve as a solid basis for educational purposes (what does arbitrage mean in real practice?) as well.


Triple deposit rates per month

First of all let’s see what was the most important ‘to do’ of an average rational Hungarian deposit owner. Actually running between 2 or 3 local offices of retail banks with the savings resulted in triple rates in a month for an individual. In order to understand the background, the owner of the deposit was entitled to receive the entire rate after the monthly period from OTP (Orszagos Takarekpenztar, the most significant player of the Hungarian banking market nowadays as well and the most freqently traded share on Budapest Stock Exchange) only if the money was on the bank account on the 26th of the given month, practically no other criteria was taken into consideration. Additionally other local institutions followed the same approach but their effective date was the last day of that month. Because Postabank employed daily deposit rates, it was beneficial to hold the savings at Postabank until the last days of the period and collecting the rates from other banks via transfering the money to them for 1 or 2 days. Transfering meant physical delivery and this explaines why extremely long qeues characterised the branch offices of Hungary that time. Due to their oldfashioned systems the banks could not change this picture significantly for many years.

Anomalies on the local fixed income market

Due to the lack of IPOs, commercial bank loans, foreign loans and notable state subsidies, local fixed income issuances were relatively popular and could serve a good basis for the Hungarians to start learning the basics of capitalism. On the other hand calculating the fair, non-arbitrage price of an interest bearing bond was practically impossible for many people. This offered a great arbitrage opportunity (often more than 5%) for a small qualified group and the cost of the transaction was practically the walking time between two offices…. Not surprisingly many university fresh graduates prolonged their career starting and HR interviews and entered into this relatively easy game.

The story of IBUSZ, the first stock on the market

The date of 21 June 1990 has historical importance in Hungary. This is the birthday of the Budapest Stock Exchange and the first trading day of IBUSZ in Budapest and Vienna. Right after the start the first bid was settled at HUF 5600 and the closing price of that day was HUF 8000. However it closed the year at HUF 4820, less than the initial issuance price. Taking into consideration the experiences of the Austrian-Hungarian Monarchy, the existence of parallel trading in two different locations offered great geographical arbitrage opportunities. Even after the deduction of trading costs the price of Budapest was significantly lower and past data explained significant correlation between the current price at Budapest and the yesterday quote of Vienna.

Playing with the swap points

In 1991 and 1992 the central bank of Hungary posted FX forward quotes on regular basis. Swap point was defined as the difference between spot and forward prices. Obviously the central bank updated its spot prices every day, however the swap points remained fixed in a particular period. Even a relatively small change in spot quotes violated the classic no arbitrage formula (forward price equals to the spot price inflated by the risk-free rate) according to which at initiation the value of the forward contract must be zero. Subject to positive or negative fluctuations in the actual market prices, spot purchase with future selling or immediate short position with forward selling were the appropriate market neutral strategies (at the costs of the central bank). Moreover usually the bank offered upward sloping curves, lower swap points for shorter maturities and higher for the longer end of the curve. In this case the beneficial trading strategy was forward purchase for the shorter maturity and forward selling for the longer period.

sources:, Tozsdesztori,