Global growth ploughs on while markets take a breather
7 July 2017
Rather unsurprisingly, investment returns’ upward momentum slowed in Q2, and in some cases reversed, following the very strong results of the first quarter. In particular, June developed very much along the lines we had anticipated, which was that, with economic growth perspectives returning from ‘gushing’ back to ‘new normal’, capital market investors reassessed valuations and concluded that there was not much headroom left.Nevertheless, investors in globally diversified multi asset portfolios, such as we run at Tatton, should still be looking at half year returns around mid-single digit levels, with only the very lowest risk portfolio strategies generating a lower 2-3% return. What made the second quarter of 2017 – and June in particular – a little disconcerting for investors is that both equities and bonds experienced disappointing returns. We wrote last week that this is unusual, as these two asset classes are usually negatively correlated. This means, when equities suffer a setback, money tends to flow into the safer government bonds, which therefore appreciate and vice versa. Then both equities and bonds fall at the same time it tends to be the result of a slowing economic outlook, combined with indications from central banks that they will raise rates regardless. Investors have come to call this a ‘market tantrum’ on the basis that capital markets appear to indicate that they are concerned about the seeming disconnect between perceived economic reality and monetary policy from the central bank(s). The last time this happened was in the early summer of 2013, after the US central bank announced a gradual reduction of further monetary easing from the autumn onwards, while capital markets remained uncertain whether the economic recovery was already firmly enough on track to justify such a move. We suspect that, just as was the case back in 2013, markets will calm down once it becomes clearer that the central banks are not committing a policy error and global economic growth remains on track – albeit stubbornly slow. This time around, capital markets are more prone to valuation level vertigo, which makes the next quarterly series of corporate earnings announcements – we call it ‘earnings season’ – all the more important. Early indications point to potentially better-than-recently-expected earnings growth. In numbers, this means that company analysts are expecting annual profit growth in the all-important US market to be around 6.6% for the 2nd quarter. Quite a decline from the lofty 14% recorded over the first quarter of 2017, but by no means a disaster. If forward looking macro data continues to re-accelerate – as both the Fed’s comments and last week’s ISM and employment data suggest – then stock markets may be inclined to view this more than halving of corporate results growth as a temporary blip, rather than a worrisome overvaluation. We are encouraged by the recent recovery in forward looking economic sentiment indicators, especially in the recently slightly flagging economies of the US and China. Earnings data across the Eurozone is expected to look more like the very strong results in the first quarter in the US and may well lead to a change in market leadership from the US to the EZ. The UK remains a special case in the Global framework due to the looming uncertainty over Brexit. We have dedicated a separate article to the latest UK productivity figures, which increasingly tell a story of a country put on hold until more clarity about its future trade position is achieved. The EU in the meantime is showing how to make the best of global free trade opportunities and just agreed high level deal details with Japan, just months after concluding a free trade agreement with Canada. We cover the implications for the UK’s own upcoming trade negotiations and what we can learn from the EU’s experience. Over the coming weeks, we expect a somewhat reduced risk of a capital market selloffs, as was pertinent over the past weeks and indeed occurred to a small extent over the past two weeks. However, the disturbing development of North Korea successfully firing - on the US’ sacred 4th July Independence Day – a rocket that could be developed into a transcontinental missile warhead, significantly raises geopolitical risk levels. It was good to observe the Chinese government harshly criticising its ally’s actions, but unless China follows up those words with action, the US may feel pressured to take action themselves. It should also not be forgotten that the conflict between Qatar and its neighbours continues to have the potential to disrupt oil supply for large parts of the leading Asian and much of the European economies. Under this general scenario of a fragile ‘truce’ between capital markets at the top end of acceptable valuation levels, stabilising corporate earnings declines, macroeconomic sentiment improvements and a somewhat unpredictable geopolitical theatre of potential conflicts flaring up, we remain content with our current equity underweight position which has served our investors well since we introduced it at the beginning of June. Please click here for the full weekly.