Global equity markets have continued to exhibit late bull market characteristics, climbing a ‘wall of worry’ to record highs, an 8-year long bull market, the second longest in history. Currencies have impacted returns over the last quarter, with sterling gaining 3.6% against the dollar, whilst falling nearly 3% against the euro.
As softer inflation and wage growth data had already seen the Dollar weaken against other major G10 currencies, this did not prevent the Federal Reserve from raising interest rates at their June meeting. US equities rallied during the quarter with the S&P 500 index gaining 2.6% in dollar terms. This was helped by better than expected results from US multinational companies which took US equity indices to numerous record highs during the quarter. All of this was supported by signs of an improving domestic and global economy in spite of the ongoing failure of the Trump administration to progress its deregulation, tax and infrastructure agenda.
Following the Fed’s latest rate rise, investors’ worries resurfaced about the outlook for global growth, inflation and interest rates. US equity markets become more volatile prompted by particular concerns about the high valuations of leading US technology companies. These high-profile NASDAQ-quoted stocks had been leading the market’s advance and so were susceptible to profit taking. Nevertheless, they continued to post a 3.9% increase for the quarter outperforming the Dow Jones Industrial and S&P indices. The dollar moved lower despite the possibility of further rate rises in September and/or December. The dollar Spot Index has now fallen during each of the last four months and dropped 3.2% during the quarter.
In the UK, Brexit negotiations with the EU are likely to become more contentious following the loss of the Conservative’s parliamentary majority. UK equity markets were noticeably lacklustre over the quarter with the FTSE-100 virtually flat, whilst the more domestically-oriented FTSE-250 was up 1.7% with the FTSE Small Cap index managing a creditable 3.47% gain.
UK economic data was mixed with retail sales and wage growth disappointing but UK manufacturing output gaining in May to reach its highest level in three years. However, corresponding figures for June saw further weakness in retail sales as well as in services growth, manufacturing output and construction data. Meanwhile, sterling strengthened during the quarter, particularly against a weaker US Dollar. The gains accelerated in June following hawkish comments by various members of the Bank of England’s Monetary Policy Committee who expressed forthright views about the appreciably above-target inflation rate as well as the possible timing of higher UK interest rates. Overall, sterling gained 3.8% during the quarter.
European markets saw investors responding positively to a plethora of better than expected economic data, upbeat corporate results and a positive political outlook following Macron’s victory in the French presidential election and his REM party’s landslide in the National Assembly elections. A shift away by investors from perceived expensive US equities into perceived better value European stocks produced a Euro-inspired quarterly gain of 6.7% for the Stoxx 600 Europe index.
Japanese equities gained during the quarter as a stronger dollar relative to an even weaker yen prompted selective buying of larger exporting companies. The Topix index rose 6.6%; in dollar terms, this makes Japan one of the top performing equity markets over the past year.
Emerging Market equities enjoyed one of their best quarters since 2015, benefitting from rising commodity prices as well as a weaker dollar in terms of local currencies. The MSCI Asia Pacific index has gained more than 15% since the beginning of 2017.
Global bond yields were volatile during the quarter. Declines in April and May were evident in response to softer US and Japanese economic data. Later in June, hawkish interest rate comments from central bankers in the US, UK, Canada and Europe caused yields to rise with the 10-year US Treasury yielding over 2.3%. Bank and financial shares have gained as a consequence of these higher yields.
Looking ahead to the second half of 2017, rising inflation and prospects of higher interest rates may well dominate both investors’ and central bankers’ thinking. We are approaching an inflection point as central banks are intent on normalising interest rates and withdrawing monetary stimulus. If support is withdrawn too quickly, then growth and equity markets could be choked. On the other hand, prudent increases in interest rates could help sustain the business cycle and corporate profits, as well as contain inflation.
There are increasing signs of market exuberance, which demand caution – equity valuations are stretched, particularly amongst technology companies and demand for some high-risk bonds is irrational – Argentina has defaulted on its debt five times in the last century yet recently sold 100-year bonds. In addition, equity volatility is at a historical low since 1945 and a flattening yield curve for bonds points to uncertainty ahead for markets. Pessimists highlight the reality check on President Trump’s growth agenda with lack of progress on de-regulation, tax cuts and infrastructure investment, resulting in a softer dollar and lower oil prices.
Yet, corporate earnings are improving and a weaker dollar should boost profits for US multi-nationals. A more measured assessment of the US economic outlook should provide a more stable platform for US equities. In addition, Europe, particularly France under President Macron, is picking up the baton, the ECB talking of persistence and prudence to drive economic growth. Modest rises in interest rates will help banks rebuild profitability and underpin corporate lending. Whilst Brexit undoubtedly poses economic challenges for the UK, growth remains more resilient than expected and UK manufacturing output recently reached its highest level for 3 years.
In our view, an improving global economy should offset some withdrawal of the accommodative monetary policy which has been in place since 2010. Politics are also likely to play a significant role with ongoing events in Syria and North Korea at the top of the global agenda. From a UK and European perspective, Brexit negotiations will almost certainly take centre stage.
Please note, our Investment Commentary is our view of markets and does not constitute investment advice. Past performance is not necessarily an indication of future returns; the value of investments and any income from them is not guaranteed and can fall as well as rise. Overseas investments are affected by currency movements and exchange rates. If you would like investment advice on your individual circumstances, please do not hesitate to get in touch.