Overall, as we move through 2018, our view on markets continues to evolve as conditions change with equities being the favoured asset class. The global economic landscape is sound with accommodative monetary policy, positive funding conditions and solid earnings growth painting a picture of supportive investment conditions.
Readers of past issues of this publication will be aware of a theme of a divergence between the US economy and those of the rest of the world. The US has been very much the leader of the pack with returns significantly higher year-to-date compared to the other main geographic regions. This, in some ways, comes as no surprise with the US closer to normalisation compared to other areas and Trump’s fiscal stimulus of enacting taxation cuts a clear benefit for US companies.
Views on the US are starting to diverge due to US valuations being at current high levels. They see convergence for the rest of 2018 as Europe, UK and Japan start to catch up. Others feel that Donald Trump’s tax cuts are positive with the long-lasting effects of potential increased capital expenditure could be felt as we move through into next year.
The recent Q2 earnings season in the US proved to be another success with earnings growth around 26% compared to 7% for Europe. The consensus view from our managers is that earnings growth will continue to be positive.
Inflation in the US is under scrutiny with the traditional Philips Curve relationship of falling unemployment leading to higher wages only just starting to be seen. If and when wages start to rise significantly, inflation could come through, leading to a more aggressive tightening of monetary policy – this will not happen if businesses manage to generate better productivity.
China is experiencing a “managed slowdown” as the Chinese Government continue their re-orientation from a manufacturing economy to more domestically focussed consumption. China has endured spats with Trump around tariffs but there is now the potential for fiscal stimulus, cutting taxation in order to boost productivity, with one of our managers estimating that the stimulus could be equivalent of 1% of GDP.
Turkey has been grabbing the headlines with the Turkish Lira devaluing significantly. Contagion from this event is very unlikely.
Emerging Markets have been a key topic discussed. Political risk and USD strength have weighed on returns with some of our managers reducing exposure in favour of developed markets. USD denominated debt has increased, however, relative to overall GDP this is stable and foreign assets have grown substantially. There is a need to be selective at a stock, sector or country level which we will see in our funds.
The UK has been the subject of many news reports in that there will no agreement in place when we formally exit the European Union at the end of March. What will happen with Brexit is unknown, but if we look back any uncertainty has played through currency markets leading to a devaluation of sterling with cable currently at 1.28. Sterling is undervalued historically however we could see some potential short-term weakness as we head towards March.
Parts of Europe have struggled earlier in the year with the rise of populism particularly in Italy. Views differ with some managers citing better opportunities elsewhere, other managers cite positive fundamentals and more favourable valuations levels, particularly compared to the US.
Within bond markets, high yield has produced some good returns recently, however, the overall risk: reward trade-off is not as favourable as other areas. Emerging Market debt looks interesting with yields at high levels, whilst others are uncomfortable around risk levels in this area.
All the above views are taken into account in our portfolios as our managers take positions to take advantage of global opportunities.
Some observers have described recent years as one of the most unloved bull markets ever. Others have sat on the side lines, worrying about risk with an over reliance on cash even when interest rates are at historic lows and inflation has eaten into capital. Our diversified approach has rewarded our clients, it avoids the pitfalls of market timing and encourages long term investors to stick to the plan.