Pollsters win again / 100 days Trump / economy slows / risk appetite returns

28 April 2017

The first round of the French presidential election coming exceedingly close to pollsters' forecasts seemed to be an almost bigger relief to stock and bond markets than the political class. With the pro-EU candidate Emmanuel Macron winning the first round and now a general expectation that he will win the presidency in the second round on May 7, European political risk has reduced very significantly.

While the stock market surge may have been a relief rally triggered by the election result, there were various good reasons for them be much less buoyant. Economic growth rates in the US and the UK halved during the first quarter, the oil price fell below the important $50/bbl mark, president Trump's first 100 days in office ended without much to show for except confusion and his announcement for a massive but highly unrealistic tax reform. This was so totally ignored by markets, that one could have even come to the conclusion that Trump's biggest 100 day achievement has been to not be taken seriously anymore.

So, has the reduction of political risk in Europe been sufficient to return stock market's countenance? Well, no, but we experienced once again that what is foreseeable is already priced in, while what is truly uncertain has the ability to move markets.

The gradual downward movement of stock markets since mid-March, as represented in the graph at the top by the blue, green and yellow lines of the main US, UK and European indices had mostly taken place in anticipation of disappointing Q1 economic data. The week's GDP numbers were therefore old news, whereas the French election outcome and the stronger than expected corporate profit numbers where positive surprises that pointed to a better trading environment for Q2.

Two further points can be drawn from the confusing chart above. Firstly that since March, but particularly with this week's upswing, equity market leadership appears to have passed from the US to the European stock markets. While we had expected this for a while on the back of the building economic momentum in the Eurozone (and positioned portfolios accordingly) it required a market decline and the French election as a catalyst to come to the fore.

Secondly, bond markets as represented by the red line in the chart might have had their short spell of recovery after their brutal sell-off in the last quarter of 2016. The disappointment over the return of more normal GDP growth rate expectations, which had stopped and then reversed the rise in yields seems to have been absorbed. Yields have stabilised at a lower level and we expect them to rise again on improving economic news. We therefore took the opportunity and reduced the duration in parts of our bond allocations, after having raised it only in February in anticipation of the bond recovery.

To be sure, while it is encouraging to see improving stock markets this week and very supportive corporate earnings results, valuations remain relatively high and therefore vulnerable to any sudden change in outlook or external shock. We are optimistic that what we have observed and anticipated will carry on and through the next 2 quarters, but we also remain vigilant and open to contrarian views and observations, given the ever-larger number of moving parts (economic variables with uncertain outcome) and politics which may be settling down in Europe, but continue to have potential for surprise in the US and the UK.

However, one concern we had at the beginning of the year has rapidly diminished over the past weeks: that the ongoing economic cycle may be brought to a premature end over 2017 due to an overheating economy!

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