| The modest acceleration in global economic growth that started last autumn continued in the first quarter but – as buoyant sentiment measures are probably over-stating the upturn – real GDP growth estimates of 2.8% this year and 3.2% in 2018 are unchanged. Headline inflation has surprised on the upside but core inflation (excluding energy) and wage growth are still low and relatively stable. The recent small rise in US interest rates does not alter accommodative monetary policy and the backdrop for corporate profitability is supportive. Broad compliance with the OPEC production agreement has kept the price of Brent crude close to $50 – marginally lower than at the start of the year. Sterling remains depressed on a trade-weighted basis although dollar weakness helped cable recover to $1.25. After rising sharply following the US election, global bond yields have traded in a narrow range with US and UK 10 year yields ending Q1 at 2.4% and 1.2%.
Equity markets have performed strongly in recent months. After reaching new highs, the S&P 500 ended March unchanged at 2,362. Having lagged the US, European markets continued to catch up with the FTSEuroFirst 300 closing up 44 at a new high of 1,503 and the FTSE 100 59 higher at 7,322. UK performance has not been limited to global multinationals and there have been good returns from the mid-cap FTSE 250 while the small cap index closed at a 2017 high. Asia and emerging markets have been the best performers and made further gains in March. In contrast, the Nikkei 225 fell 210 to a 2017 low of 18,909. Emerging economies, notably China and India, continue to have the fastest growth rates. Premier Li Keqiang’s Work Report in early March reaffirmed the Chinese government’s twin economic targets of 6.5% GDP growth and 11m new jobs. Although infrastructure investment is expected to be similar to last year, personnel changes mean experienced technocrats now head the key economic, trade and regulation institutions. Recent data has been encouraging but the first monthly trade deficit for three years and weaker retail sales highlight the difficulty of maintaining growth at current levels. GDP growth of 7% in India has been resilient in the aftermath of demonetization while BJP electoral success increases the likelihood of legislation being passed on contentious structural reforms. The pick up in global trade has helped exports and activity in Asian economies including Korea and Taiwan. However, the region’s high growth is still not self-supporting and remains vulnerable to any change in US trade policy. Financial markets’ enthusiastic reception to the prospect of US reflation has not yet been matched by reality. Post-election uncertainty has impacted spending while inventory drawdown and mild weather conditions are expected to dampen GDP growth in Q1. The pace will pick up in Q2 as the new administration beds in but – assuming President Trump’s ambitious policies are not watered down – the fiscal stimulus from corporate tax changes/infrastructure spending will not be apparent until well into 2018. Current estimates are for 2.1% growth this year and 2.5% in 2018. Over the coming months budget drafts and the Treasury report on the FX policies of major trading partners should provide some clues on border taxes and potential changes to international trade – both of which could have a material impact on US corporates. The robust economic backdrop and full employment give the Federal Reserve an opportunity to normalise monetary policy and at least two more rate increases are likely in June and September. Perhaps more important is the anticipated announcement later this year on tapering the Fed’s balance sheet investments. The unwinding of quantitative easing in Europe and Japan is still some way off although central banks are becoming more hawkish. Assuming there are no economic setbacks, stimulus could start to be reduced late this year or early next. Estimated GDP growth of 1.4% in Japan is marginally above potential and being driven by a pick up in exports, business investment and government stimulus. Yen depreciation following the US election will boost manufacturing profits significantly. Core inflation of 0.7% may fall as static wages combined with low consumer inflation expectations and spending give the corporate sector little pricing power. GDP growth in the Eurozone is expected to be 1.7% but the outlook is mixed across the region and, although labour reforms have helped reduce unemployment, there is little evidence of sustained wage growth. The German Ifo and purchasing manager indices suggest a strong manufacturing upturn is underway with Spain and Ireland performing above average but France and Italy facing economic as well as political challenges. Continuing uncertainty about bailout negotiations, capital controls and a further contraction in government spending are constraining GDP in Greece but a compromise is likely given the EU cannot afford ‘Grexit’ or a disruptive default. The ambivalent reaction of UK consumers to the EU referendum may reflect a ‘buy at current prices while stocks last’ approach. Exports have not picked up sufficiently to offset the slowing momentum in consumer confidence and impending fall in real disposable incomes. The triggering of Article 50 will create uncertainty at a time when making a success of ‘Brexit’ requires significant investment in resources, skills and infrastructure to improve productivity and ensure the UK remains competitive. The legacy of the financial crisis is also a constraint so, while the Budget confirmed that government finances are marginally better than expected, the scope for fiscal stimulus is limited by the amount and cost of servicing outstanding public debt. Estimated GDP of 1.8% this year is likely to slow to 1.5% in 2018. Interest rate increases are unlikely before 2019 despite unemployment below 5% and the possibility of a temporary rise in CPI inflation from 2.3% to over 3%. However, the challenges facing the domestic economy have relatively little impact on quoted companies as their sales and profits are predominately global. Market momentum has slowed as political rhetoric meets economic reality. Our view is that the US has the financial capacity to support a ‘reflation trade’ but as the timescale has been pushed out a period of equity consolidation is likely. One of the main supports for markets is that, after several years of slightly disappointing profits, corporate earnings should recover strongly in 2017. This mainly reflects the turnaround in energy and mining as well as financials as banks restructure, loan demand picks up and higher bond yields improve margins. Global earnings are expected to rise over 14% this year and around 10% excluding commodities. The high weighting to energy suggests UK profits could increase by over 20% – similar to emerging markets – and double the 10% estimated for the US. Despite the region’s relatively lacklustre growth prospects, exposure to exports, cyclical industries and financials will help Eurozone companies increase profits by 18%. Some of the improving outlook for earnings has already been discounted but a prospective average valuation of 16x and a 2.5% dividend yield (4% in the UK) should allow equity indices to make further modest gains. This communication has been prepared for information purposes only and is not a solicitation, or an offer, to buy or sell any security. The information on which it is based is deemed to be reliable, but has not been independently verified nor do we guarantee accuracy or completeness. Investors should remember that the value of investments, and the income from them can go down as well as up, and that past performance is no guarantee of future returns. |
