Global Financial markets continue to prosper in 2017 as positive economic activity worldwide is driven by accommodative monetary policy and, in most cases, negligible inflation. Whilst unemployment numbers continue to fall, low rates of wage growth and muted productivity have kept interest rates and bond yields artificially low when compared to previous periods of global economic expansion.
United States Sets the Pace
As usual, the positive tone in global financial markets has been set by Wall Street, where all the major stock indices are at or very near their all-time highs. Despite the political fall-out from the Trump administration and the lack of progress to date on major legislation, US markets have instead chosen to focus on the strength of domestic and international economic growth and the outlook for higher corporate earnings. In addition, the Federal Reserve has begun to raise short term interest rates as well as setting a timetable for the removal of the emergency monetary accommodation [QE] which was put in place following the 2008 financial crisis.
To date, both the US equity and bond markets have taken the modest increases in interest rates in their stride. Although certain US stocks are arguably expensive at current prices, the uptick in economic activity combined with better than expected earnings growth in key sectors continues to support valuations. Looking forward, the US market is now focused on the proposed taxation legislation which is about to be introduced in both the Senate and the House of Representatives; the resulting tax cuts and possible changes to the US personal and corporate tax codes should positively impact US economic growth as well as the profitability of many US companies. It might also help take the spotlight away from the ongoing political events in Washington DC and geopolitical problems facing the Trump administration in both North Korea and Syria.
UK Interest Rate Rise
The recent 0.25% rise in UK bank rate to 0.5% (reversing the August 2016 cut) was clearly a tough call for the Bank of England’s Monetary Policy Committee. Faced with inflation above 3% (and rising) together with unemployment (at 4.3%] near a 42-year low, the Committee decided to bow to market pressure.
This was notwithstanding slowing growth in UK factory orders in October and UK retail sales which declined the most in six months to the end of September; add to that anaemic wage growth of around 2% and an economy only likely to expand by about 1.7% in each of the next three years, then this rate rise was clearly borderline.
With regard to UK financial markets, where the interest rate rise had already been discounted, the focus quickly shifted back to the Brexit negotiations. These talks will likely continue to cause volatility in sterling and, by implication, the share prices of many multinational companies in the FTSE-100. To date, although such sterling volatility has not stopped the FTSE-100 reaching record levels, the index has still underperformed both domestic mid- and small-cap indices as well as major European stock markets over the past year.
Continental Europe Picks Up
European stocks continue to make progress helped by upbeat economic numbers, particularly in manufacturing and services growth, with September German factory orders at their highest year-to-date. Although Eurozone producer price inflation accelerated in September as a result of recent weakness in the euro, this was offset by a continuing benign outlook for Eurozone consumer price inflation. This positive backdrop has seen Eurozone investor confidence reach its highest level in more than ten years. The economic outlook has also helped the Stoxx Europe index rise to its highest level in over two years and Germany’s Dax index to its highest on record. Conversely, EU bond yields have remained in a very narrow spread given the ‘dovish’ plans for withdrawal of QE bond purchases (as recently outlined by the ECB) and associated weakness of the euro v’s the US dollar and other major G10 currencies.
Japanese Elections Boost Market Performance
The Japanese stock market has been the best performer year-to-date of the developed nations (in local currency terms) with the Nikkei 225 index rising to levels last seen in 1992. The continuing accommodative monetary policy being pursued by the Bank of Japan has seen the yen weaken significantly against the US Dollar encouraging share price rises in export-oriented stocks. The stable political backdrop, following the re-election of premier Shinzo Abe’s Liberal government, and optimism over future corporate earnings have also encouraged foreign investors to increase their weightings in Japanese stocks.
Following recent upbeat economic data coming out of China and the 5-yearly Congress, local stock markets have rallied taking the benchmark Shanghai composite index to a two-year high. Similar positive sentiment towards Chinese stocks traded in Hong Kong has seen the Hang Seng index hit its highest level in over a year. Stable bond markets and muted moves in the Chinese Yuan have also encouraged investors to take a positive view of the economy and the outlook for 2017 domestic companies’ earnings.
Emerging Markets Benefit from Oil and Commodity Rally
Emerging markets have been boosted by the recent rally in oil prices as well as in the prices of base metals and iron ore. The MSCI Emerging Market index has now reached its highest level in more than six years. Although these gains primarily reflect stock market moves in China, India and other Asian economies, it should be noted that Latin American countries such as Argentina and Peru (in addition to Brazil) have also rallied significantly with the increasing oil, raw materials and other commodity prices. EM sovereign debt is also enjoying support from international bond investors as improving credit quality and high running yields make these bonds attractive relative to developed market offerings.
Central Banks Set Market Direction
With most stock markets now at or close to all-time highs, investors need to be aware of central bank policies, particularly in the US and Europe, with regards to the gradual removal of accommodative monetary stimulus (i.e. QE). Both the Federal Reserve and the ECB have plans in place to effect a gradual withdrawal of QE and so eventually reduce the size of their respective balance sheets re previous bond purchases. Allied to the reduction in stimulus, the Fed is also looking to raise interest rates further in 2018 over and above the two / possibly three increases in 2017. Whilst global growth should mitigate such rate rises, the Fed will continue to monitor inflationary pressures, so as to ensure core consumer inflation doesn’t rise above their 2% target.
Focus on Corporate Earnings
Given the growth presently being exhibited by the global economy and the translation of this growth into higher corporate earnings, we will continue to ensure that our discretionary portfolios are fully exposed to equity-focused funds across international as well as domestic stock markets. We will also try to maintain a balance between funds investing in large-cap multi-national companies and funds that invest in small- or mid-cap stocks more dependent on domestic economic growth. Similarly, our income-producing strategies will continue to draw on funds with exposure to international corporate earnings and / or potentially higher yields from global bonds.
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.