The synchronicity evident in the global economy at the beginning of the year has evolved into a clear divergence between the United States and the rest of the world.
In the United States President Trump’s tax cuts have continued to power the economy and provide a positive boost to equity markets. There is a school of thought that the one-off tax cuts at the end of 2017 were merely a short term sugar rush that will soon be played out. However, all the indications are that the effects from the stimulus will be longer lived and extend well into next year. Unemployment is at record lows and wages have risen in real terms, outstripping inflation. The US consumer is on a roll and confidence is high.
In addition, the tax reforms have encouraged the repatriation of $2.6 trillion of overseas earnings held offshore by corporate America much of which will be used to fund special dividends and share buy backs which should continue to drive US markets well into next year. A subject we covered in the last issue of True Insight.
The way, as ever, is not entirely clear. The escalating trade war with China remains an issue while the strength of the dollar and the Federal Reserve’s determination to raise interest rates twice this year and three times in 2019 could slow the economy. However, while the Fed appears resolute in its intention to “normalise” interest rates, it remains alive to the effects of continued tightening and is unlikely to pursue any policy that might jeopardise the ongoing economic expansion.
In Europe the embryonic stirrings of monetary tightening are also evident but at a much slower rate. Quantitative Easing is being scaled back and will end this year but Mario Draghi, President of the European Central Bank, has signalled that interest rates will not rise for another year or so.
The continuing Brexit negotiations mirror past months and political disquiet in Italy appears to be ever present. Sabre rattling by the anti-euro Italian coalition government has become more subdued in recent weeks and for all the firebrand rhetoric severe doubts remain as to whether there is the political or popular appetite for a significant confrontation with the EU.
To many of our fund manager partners Italian table thumping represents just another day at the office. They mostly retain a neutral weighting, attracted by low valuations and the promise of accommodative monetary policy but remain wary of the uncertainty created by the UK’s departure from the European Union and the potential for Italian politics to unsettle the economic outlook as well as the political status quo.
Japan. Attractive valuations and an absence of immediate, idiosyncratic issues have increased Japan’s appeal amongst global markets. Valuations remain attractive and monetary policy accommodative.
Within Emerging Markets opinion is divided. So far, the situation in Argentina, Venezuela, Turkey and South Africa is localised and specific with little risk of spreading. The managers with large positions in developing economies are, by and large, maintaining their holdings, regarding the current volatility as a necessary cost of harvesting the long term rewards that accrue from investing in the region and, of course, opportunities to buy. We are seeing a greater proportion of EM debt denominated in local currency, the strong dollar and rising US interest rates and the effect on Emerging Market assets will be kept under close watch.
UK. Over the month the UK has been weak the causes being a step up in the rhetoric around Brexit and lacklustre commodity prices which have impacted upon the resource heavy main index. There appears to be a lack of momentum to the market with our managers focussing on other global markets. That said, economic growth continues to surprise, valuations remain attractive and the technical indicators point to a market very oversold and due for a bounce back.
We are now at the end of the quiet summer where news is amplified, we expect to get a directional steer when third quarter results are published next month. In the meantime, market movements continue to expose opportunities which we remain perfectly positioned to capture.