Jonathan Marriott – Chief Investment Officer
So far this year, financial markets have been characterised by bouts of weakness followed by strong equity market recoveries. In February, markets were dominated by fears of Chinese growth slowing and the belief that this could lead to a knock-on effect for global growth. The sharp selloff was followed by a steep recovery in March; Chinese data came in better than anticipated and the concerns from February began to fade. Another market downturn came around the time of the UK’s referendum on whether to leave the EU, owing to concerns that this would damage global trade and increase political uncertainty. Again, the effect was short lived and equity markets quickly rebounded. Overall, investors have needed to keep calm and avoid selling into these times of uncertainty.
However, it is important to note that many of the factors that have led to prevailing concerns have yet to disappear. Chinese growth is still lower than in recent years and the impact of the Brexit decision is perhaps yet to be felt. Some changes have stuck; the pound fell in value after the Brexit vote and interest rates in the UK have been cut, with the consensus now that they are more likely to fall further than rise in the coming year.
The Bank of England cut rates after the referendum and is buying bonds, reducing longer-term interest rates. This has supported equity prices but has also caused weakness in the pound. Sterling weakness makes exporters more competitive, makes the UK cheaper for overseas investors and increases the value of overseas earnings for UK listed companies. All this is good for the stock market and is countering any effect of delays in contracts and investment that uncertainty over Brexit may be causing. Nonetheless, the other effect of currency weakness is that import prices rise. This causes a rise in inflation that may lead to increased wage demands. Annual inflation has been depressed by falling oil prices but as we move into the New Year, this effect will come to an end. As a result, we expect inflation to pick up. In normal situations, this could encourage the Bank of England to raise rates but in the current circumstances, this seems unlikely. Low interest rates and rising inflation is not good news for savers holding cash.
In the US, the Federal Reserve started the year expecting to raise interest rates four times in 2016. Over the course of the year, this expectation has gradually fallen and their expectation for long term interest rates has progressively declined with it. At the September meeting, they left open the possibility of a December move but even this may be called into question depending on the impact of the US election next month.
We are now entering a period of intense geopolitical activity. The US election, particularly the possibility of President Trump, raises many uncertainties. Clinton may be seen as a continuation of the old regime and Trump raises a greater degree of uncertainty. Of particular concern are Trump’s protectionist trade policies which may harm global trade but may support the dollar and domestic companies. A month after the US election, we have the Italian referendum on constitutional reform. While not about the EU as such, it is seen by many as a popularity vote on EU membership. The result, at this time, is too close to call. Next year we have elections in Germany and France that may show further evidence of the rise in populist anti-EU parties. These have the capacity to make UK negotiations with the rest of Europe particularly difficult and we will continue to monitor them closely.
Overall low interest rates and low growth appear to be here to stay and while equity markets may be supported by low interest rates, we need to be selective in our approach. Higher equity prices and low interest rates are likely to lead to further periods of volatility. Upcoming political events are unlikely to help this mood but the noise from this direction may prove greater than the impact on markets in the long term.