This post is also available in: 
Français
Economic and market commentary
Equities continued to make new highs as we moved into 2017, but
we are mindful that the outlook is littered with macro-economic
and political risks – not least the forthcoming elections in France,
Holland and Germany, Article 50, and President Donald Trump.
Unlike late last year, when specific sectors such as financials and
energy drove the bulk of global returns, the latest rally in stocks
has been broader based.
A weaker sterling has driven UK equity
performance, though a recent speech by Prime Minister Theresa
May on Brexit negotiations saw sterling leap higher, knocking
back the FTSE 100 somewhat.
President Trump
Equity markets have of late focused on the growth aspect of
‘Trumponomics’ with the belief that Trump is good for US and
global growth, as well as corporate profits, all of which is
supportive for equities. In the US, earnings have been improving,
largely on the back of a rising oil price and the US dollar, not to
mention a robust consumer growing in confidence causing the
market to rally. If President Trump can deliver his tax and fiscal
promises in full as well as finding a constructive approach to
international trade, then there is little reason why the current rally
should not continue.
Underemployment suggests there is still space in the labour
market and there is only moderate wage pressure coming through.
Until inflation starts to pick up there will be no need for rate rises
and the market can continue its recent trajectory. Add to this
Trump’s mooted tax cuts in all their guises and this will only
improve the environment for businesses and consumers. If the
recent spike in small business confidence numbers are anything
to go by Trump has improved corporate confidence and, as we
know, markets continue to do well as long as their confidence
doesn’t wane.
That said, alongside Trump’s tax cuts are his potential tweaks to
trade tariffs, while few have been able to unravel in full the
complexities of any amendments he makes to the US Border
Adjustment Tax that could see both manufacturers that assemble
parts from overseas as well as those importing manufactured
goods into the US charged higher tax rates.
It seems clear that these factors will be bad news for emerging market manufacturing and any
increase in protectionism associated with Trump could be very damaging for companies with
global supply chains, as indeed could an increase in labour bargaining power.
Yet the risks we
see may well be tempered by supportive fiscal policy in the US and monetary policy in Europe
and Japan. Global quantitative easing outside America will help keep a lid on rates, which
makes for a reasonably benign, low-rate environment alongside decent growth.
While corporate credit and equities appear to be pricing in better economic growth, core fixed
income is moving oppositely. There are several plausible explanations for this divergence, not
least of which is that inflation expectations have increased in core fixed income markets,
suggesting they might also be pricing in the better growth suggested by equities. An end to the
global profits recession – with global earnings revisions at multi-year highs, is also a likely
explanation for better equity performance.
Portfolio positioning
In terms of portfolio positioning, we have been looking whether we are in a bubble in high yield
corporate credit. Clearly it’s not cheap, with yields at record lows and spreads tightening to latecycle
levels; but interest cover is reasonable, while defaults have (at least temporarily) fallen on
the back of recovering energy prices. For now, we are happy not to move more neutral but we
are keeping an eye on the risks to that view, not least if US growth begins to accelerate by more
than we have anticipated.
Last year was a difficult one, leaving many investors feeling bruised. Cash balances are still
high among equity investors, but we remain cautious (and sometimes reluctant) owners of risk
assets, a strategy that has served us well, particularly in our asset allocation portfolios.
We
expect volatility to be present throughout 2017 but, as active managers, we will continue to look
for opportunities to add to our high-conviction positions.
Add Comment