15 May 2017
A fortnightly look at global financial markets
Tom Elliott, deVere Group’s International Investment Strategist
Near-term market sentiment: Solid, justified by improving U.S and eurozone economic data and first quarter corporate earnings results. Friday’s strong April employment data (+211,000 new jobs) appears to confirm the Fed’s comment earlier in the week,
that weak U.S first quarter GDP growth of 0.7% at an annualised rate was a temporary blip. The prospect of U.S tax reform and infrastructure spending policies being passed by Congress has increased, following the House of Representative’s passing last week of a new healthcare bill that abolishes Obamacare. S&P500 first quarter earnings are ahead of expectations, at 11% growth over the same period last year. In the euro zone, stronger growth and inflation are leading to improved business and consumer confidence. Macron’s likely victory in the second round of the French election reduces regional political risk leading to perhaps a good week ahead for European stock markets, and a narrowing of French and peripheral euro zone bond spreads over bunds. The Stoxx 600 pan-Europe index has seen a 12% increase in first quarter earnings over the same period last year. Yet bond markets remain stable, with a modest tightening of U.S monetary policy priced in.
Broad economic and political assumptions for rest of this year: World GDP growth continues to accelerate, from 2.9% last year to a forecast of 3.5% in 2017 (IMF estimate), which is feeds through into solid corporate earnings growth. If Trump succeeds in getting his healthcare policy through the Senate, and into law, opposition by Republicans in Congress on other policies is expected to weaken and the outlook brightens for tax cuts and infrastructure spending policies. Consensus estimates for GDP growth remain around 2.3% will still be respectable. Another two rate hikes from the Fed this year remain likely, with markets pricing in a 94% chance of the next one being in June. But weak wage growth keeps inflation expectations down and bond yields stable. Dollar to be flat, metal prices remain highly sensitive to China growth data. Oil trades $50-$55 a barrel.
A large increase in the Conservative Party’s majority in Parliament after the 8th June election should allow the U.K government to negotiate a smooth transitional arrangement for a softer Brexit than previously expected, but it is unclear whether either side in the negotiations want talks to go smoothly. Sterling to remain sensitive to Bexit negotiations. Within the E.U, it is the Italian election (to be held no later than next spring) that appears most likely to deliver the next populist government after those of Hungary and Poland. In France, Macron will struggle to push through reform policies given the lack of a parliamentary majority for his party, but his support for the E.U helps the organisation deal with Brexit and progress with a banking union. Angela Merkel to remain Chancellor in the autumn German elections.
Taking the above assumptions into account: Remain fully diversified, with perhaps a bias to the Europe ex UK region funded through an underweight position the U.S. European political risk is likely to continue to fade and growth to accelerate, while in Japan Abe will continue with his ‘third arrow’ of structural reform despite recent personal political setbacks. Dividend yields in the euro zone, the U.K and Japan remain comfortably higher than those of comparable government 10 yr bonds, but in the U.S the S&P500 yield is less than that of the 10yr Treasury - which suggests stretched valuations. Investors in large cap U.K stocks may be hoping for a hard Brexit. The prospect of a softer Brexit, should the post-election U.K government choose to pursue it, is good for sterling and so negative for the FTSE100 index due to its international exposure. Neutral emerging markets: corporates appear vulnerable on account of the burden of dollar-denominated debt taken on over the last decade, and an over-reliance on the Chinese and U.S economies with domestic demand growth having lagged export growth.
If U.S and European wage inflation remains modest, further gains may be had in fixed income but caution is advised. A bias towards short duration and limited exposure to high yield -which appears expensive- perhaps yielding the best results.
A balanced fund for the long term. The chart below shows a typical long-term balanced portfolio based around 60% global equities and 40% global bonds. Financial history shows this combination to offer good returns relative to risk (ie, volatility). Investors should try to be as diversified as possible, perhaps using the 60/40 model as their guide. Multi-asset funds based on this principle are available, often with different ratios of bonds and equities depending on the level of risk suitable for an investor. Note that the chart shows neutral weightings for the long-term investor, it does not incorporate the near-term weighting suggestions of the previous paragraph.