Brexit, elections and Trump: Global equity mid-year review and outlook

Robert Lea, new Head of Global Equity Research at Ashburton Investments.

Robert Lea, Ashburton Investments' new Head of Global Equity Research provides some thoughts on what has driven markets so far in 2017 and what to expect in the second half.

Financial markets seem to have taken President Trump’s eccentricities and Brexit negotiations in their stride. Why have markets risen when they might have been expected to be flat or fall?

Global equity markets have performed well year-to-date, for a number of reasons. First, the growth outlook in the global economy has improved, with the OECD forecasting global GDP growth of 3.5% in 2017 and 3.6% in 2018, versus 3% growth in 2016. Second, markets remain awash with liquidity as the world’s leading central banks have maintained loose monetary policy. Third, global equities benefitted from net-inflows during the first quarter, as investors began to rotate from bonds to equities on the prospect of tightening monetary policy in the US. Fourth, the weakening of US inflation data since February gave rise to the view that the US might raise rates at a slower pace, which boosted sentiment in developing market indices and put additional downward pressure on the US dollar. This in turn gave a boost to bond prices and helped underpin the positive sentiment towards US equities.

While Trump’s presidency has been beset by multiple problems so far, investors should not forget that the President’s core policies are pro-job creation and pro-growth. While we are doubtful that Trump will succeed in getting many of his reforms through Congress, the prospect of superior US growth is still welcomed by the markets. The market also reacted positively to Trump’s more conciliatory stance towards China, following his earlier protectionist statements. As a result, the markets have so far been willing to overlook the political uncertainty in the US, choosing to focus on the positive outlook for economic growth and corporate profitability.

While Brexit is a risk to the UK economy, it remains a largely domestic affair that is unlikely to have much direct impact outside Europe. Concerns about the impact of Brexit on the UK economy have triggered a devaluation of the Pound, though this has so far had a positive impact on local index, given the high proportion of export-orientated companies in the FTSE 100. We remain cautious on domestically focussed UK companies given the significant uncertainties posed by the Brexit process.

Why is market volatility so low and should we expect it to increase?

The VIX volatility Index remains near record lows. While some might read this as an indicator of market complacency, it does not imply volatility is about to break higher. In our view, the VIX tells the investor more about past and current market conditions, than it does about the future.

We live in uncertain times and geo-political risk is ever present. Volatility will likely rise at some point, though predicting the precise timing of such a development is difficult. That said, we do expect market volatility to rise in the second half of this year, as central banks likely begin to withdraw economic stimulus. Slowing growth in China also needs to be monitored carefully.

Which markets have outperformed so far in 2017?

Emerging markets have been the star performer year-to-date, underpinned by the improving global growth outlook, weakening US dollar and a solid rise in local corporate profitability. Ashburton has core investment expertise in the emerging markets and our Chindia Equity Fund is up 32.6% year-to-date.

…and which have been the sectors to avoid?

Energy and commodity stocks have underperformed YTD, due to the decline in oil price and general weakness in commodity pricing. The Russian stock index has fallen more than 10% YTD, due to concerns on the domestic oil-intensive economy, as well as general geopolitical concerns. Ashburton Energy Fund manager, Richard Robinson, remains positive on the longer-term prospects for re-balancing in the oil market.

There has been speculation that the market is over-valued. Are you expecting a fall?

While valuations do look fuller in some markets – particularly the US – this does not necessarily mean we are heading for a fall, as the general back-drop for global equities is positive. Bear markets are normally caused by recessions and, although we do see a rising risk of a slow-down in global growth during the next three years, we think the probability of a recession in the next 12 months is low. This is not to suggest there will be pull-backs and we do expect volatility along the way.

What are likely to be the key drivers for the rest of 2017? What economic indicators will you be watching?

The key question for investors during the second half will be the extent to which bond and equity markets can withstand the gradual withdrawal of monetary stimulus, given the Fed’s plans to reduce its balance sheet and the potential reduction of quantitative easing by the ECB. Growing dissent within the BOE’s MPC could also herald a rise in UK interest rates, though we think this less likely given the Brexit-related uncertainties overhanging the UK economy.

While US growth has slowed so far this year, we believe the economic outlook for the American economy remains positive. US corporate profitability remains strong and the unemployment is low. We expect labour market tightness to translate into stronger wage growth, which in turn should generate higher domestic US inflation. Should this come to fruition, we would expect the Fed to continue tightening monetary policy – albeit in a gradual fashion.

A strengthening US inflation outlook could reverse the recent US dollar weakness. A stronger dollar would likely have significant implications across a range of global markets and sectors, and would be a potentially unwelcome development in the emerging markets. A rising interest rate environment is also potentially negative for fixed income and so called ‘bond-proxy’ high-dividend yielding stocks. We could therefore see a resumption of the earlier outflows from fixed income, into equities, that occurred at the beginning of this year.

We continue to keep a close eye on developments in China, where we expect economic growth to slow during the second half. Maintaining economic stability remains a central aim of the Chinese Government, which we think has done a good job so far.