Financial markets consolidated in April with mixed results across regional equities and small positive returns for fixed interest – notably, for UK investors, index-linked gilts. While the S&P 500 rose 21 to 2,384 and the FTSEurofirst 16 to 1,519 – both reflecting strong corporate results – the FTSE 100 fell 119 to 7,203. UK mid cap companies bucked the trend with the FTSE 250 gaining 644 to 19,615 – its high for the year. Asian and emerging markets also gave back some of their recent gains.
Hopes of a fiscal boost leading to a significant acceleration in the US economy have faded. While tax reforms should provide some additional stimulus, these will be more modest than anticipated, are unlikely to be agreed until later this year and will not be implemented until 2018. Despite weak Q1 GDP – reflecting inventory de-stocking and the impact of mild weather on utilities – the rest of 2017 should see modest growth of 2.1% supported by the favourable financial backdrop and a strong jobs market. The Federal Reserve is on track to raise interest rates again in June and September as part of the process of normalising financial conditions. Providing the economy continues to strengthen, this is unlikely to derail the recovery.
In contrast, Chinese Q1 GDP accelerated to 6.9% year-on-year. However, the subsequent slowdown in the latest purchasing manager indices supports our view that growth in both the manufacturing and service sectors will decelerate over the rest of the year resulting in GDP of 6.6% for 2017. Although interest rates remain unchanged, monetary conditions have been tightened significantly by cutting central bank liquidity, regulatory tightening and improved enforcement. The policy mix is aimed at balancing the need to dampen property speculation while maintaining currency stability against the dollar. Other advancing economies are also performing well with growth in India expected to increase marginally as the impact of demonetising large denomination notes fades. Korea and Taiwan continue to benefit from the recovery in exports.
The outlook for commodity-based economies remains favourable. Last year saw strong commodity price gains as China experienced a housing boom and energy and mining sectors achieved a better supply/demand balance. This year slowing Chinese demand has impacted iron core and copper but the steady improvement in global manufacturing purchasing manager indices since mid-2016 to multi-year highs suggests robust demand for commodities. At $47, Brent crude is towards the lower-end of its six month price range despite reasonably high levels of compliance with OPEC’s November production cut which we expect to be extended. Although US production is set to rise, this will not meet increased global demand. If OPEC and Russian supply cuts hold, we anticipate the oil price rising in H2.
The manufacturing upturn has also improved the GDP outlook for Japan and Europe. Germany, Spain, Ireland and Portugal are all experiencing stronger growth – largely as a result of exports. The French economy is under-performing and heavily distracted by politics. Of the larger economies, Italy is the laggard and – with 0.8% growth expected this year and 0.5% in 2018 – an anti-Euro government and renewed concerns about bank stability cannot be ruled out. Capital controls and new austerity measures in Greece are preventing any meaningful recovery as the bailout saga rumbles on.
Early polls suggest the snap UK election called for 8 June will increase the Conservative majority and improve the prospects of negotiating a controlled EU exit after 2019. Large short positions ensured a 3% rebound in sterling to $1.29 following the announcement. Given opposition disarray, there is little likelihood of election giveaways which is just as well with the UK economy starting to flag. Although the manufacturing sector accelerated in Q1 despite lower export volumes, retail sales fell for the first time since 2013, services and construction activity slowed and house price inflation declined to around 3% in March from a peak of 10% in 2014. Real wages are expected to fall this year and, with savings rates already close to record lows, this will act as cap on consumption Lower levels of business investment have probably plateaued for the time being and the contribution from government remains stable. Recession is unlikely and GDP estimates of 1.8% this year and 1.4% next are only marginally below the Eurozone average.
Q1 corporate earnings are likely to have been among the strongest in recent years. The improvement is broadly based geographically and across industrial sectors with revenues and earnings exceeding expectations by a significant margin. For US companies, the 6% year-on-year revenue increase boosted earnings by 12%. The major contributors were the recovery in energy, materials and financials while IT surprised on the upside as companies increased capital expenditure. Eurozone results were even stronger albeit the cycle has lagged the US and is therefore starting from a lower base. Share price reaction has been relatively muted suggesting investors had largely discounted the results. Looking ahead, management guidance is being revised up and this – together with positive signals on bank lending and the new orders component of business surveys – suggests there is more good news to come. 2017 could be one of the rare years when earnings exceed even the most optimistic forecasts.
Markets remain close to all-time highs. Despite some short-term weakness in the economic data, we believe the global economy will grow 2.9% this year and 3.2% next. Inflation pressure from commodity prices will ease marginally and, although wage growth is contained, this needs to be monitored closely in view of the high employment rates in many advanced economies. There will also be further scrutiny in coming months of plans by central bank to phase out quantitative easing and shrink balance sheets but this process is likely to be implemented over several years. While lower new issuance will help dampen rates, bond yields can be expected to rise gently from near multi-year lows as the economy expands. Equities remain our preferred area. Although there are no obviously ‘cheap’ financial asset classes, a 16.6x valuation for global equities and 15% forward earnings growth does not appear excessive given the outlook we envisage. The US is at the upper end of the regional valuation spectrum with the UK and emerging markets towards the lower end. We marginally prefer companies with earnings geared to the anticipated cyclical upturn. Those able to generate excess cash to fund real dividend growth and situations where management can exercise ‘self-help’ measures continue to be attractive areas.
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.
