Jonathan Marriott – Chief Investment Officer, LGT Vestra
2016 was an extraordinary year with the vote for Brexit and the election of Donald Trump at the top of the pile for political pundits. Both events carried dire health warnings but investment markets took them in their stride and appeared to “keep calm and carry on” and we have seen a healthy start to the year for equity investors. At the start of this year economic surveys are indicating that they were right to do so. Many indicators around the globe, from China in the east to the United States in the west, are doing better than expected. Even data in Europe has come in better than originally anticipated. Despite the uncertainties about Brexit, the UK Economy appears robust, supported by a weaker currency and low interest rates. However, as we expected UK inflation is rising and this may cause difficulties if wages fail to keep pace.
We have seen inflation picking up in many parts of the world but in the UK it is likely to be particularly painful as the fall in sterling and the recovery in oil prices feed through to retail price inflation. Unless the currency falls further and the oil price rises then these effects may be temporary. If wages fail to keep pace with inflation then higher prices may weigh on economic growth; as a result, we believe the Bank of England will be reluctant to raise interest rates in the near future. The outlook for the UK economy remains shrouded by the outlook for Brexit negotiations. This March, Theresa May finally exercised Article 50 but her letter and the EU response indicates there are significant difficulties to be resolved. Indeed, they have not even agreed the negotiation process. The UK government wants all talks on trade and the terms of exit agreed at the same time but the EU are only willing to negotiate on trade once the terms of exit have been agreed. We would not expect negotiations to flounder on the Rock of Gibraltar but there will be plenty of bumps along the way as we move towards the exit door. Amidst this we need to remember the UK equity market is very international and may be driven more by external factors than the domestic economy. We have waited six months after the referendum for Article 50 to be triggered and I am reminded of the Churchill quote “Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning”.
The big topic globally has been the election of Trump and what it means. Policy by tweet is hard to predict but, since the inauguration in January, we have had an insight into what a Trump presidency is about. He has appointed a team that is generally business friendly but has clashed with Congress despite Republican control. One of Trump’s top campaign promises was the replacement of Obamacare with a cheaper and better healthcare system. This was going to be one of his main cost saving policies that would enable him to reduce taxes and spend more on infrastructure and the military. The Republican Congress could not agree to his healthcare changes and has given him a dose of real politics, which as a political outsider, he has little experience of. At the end of last year there were high hopes of expansionary policies but as he enters the finer details of budget negotiations he may find more promises that are hard to keep. For now the US economy is growing, unemployment is low and the Federal Reserve has been able to raise interest rates without disrupting the financial markets. The US economy does not appear to be the disaster that the pre-inauguration Trump suggested.
Last year we saw the rise of populist parties across Europe and the vote for Brexit and Trump added to fears that European politics could upset markets this year. Elections in the Netherlands, France and Germany were a particular concern with the rise of maverick right-wing politicians. However, we have passed the first hurdle of Dutch elections without a political surprise. The next big hurdle will be the French presidential elections where Marine Le Pen and the Front National have been showing well in polls for the first round of the presidential vote. At present it looks as if she will lose out to Emmanuel Macron, a more moderate political outsider, in the second vote. However, if last year has taught us anything it is to be wary of what political pollsters predict. German elections in September and possibly an election in Italy only add to the uncertainty. Despite the vagaries of politics there are signs that the European economy is improving with survey data showing a pickup in activity. Europe may finally be benefitting from European Central Bank stimulus and better growth globally.
Political tensions have been high and have dominated discussion but, in the background, economies are doing better than expected and equity markets have responded well. Valuations, by some measures, are looking stretched but many companies’ earnings are improving. In the US, we expect the Federal Reserve to raise rates further however this is now priced in and, as such, should no longer come as a surprise to markets. Globally, central banks have supported markets since the financial crisis. Over the months and years to come we may expect this stimulus to be gradually reduced but, as with the Federal Reserve, we expect this will be against a stronger economic background and may be achieved without disrupting markets. For now, the economic survey data appears to support market valuations and as we enter the second quarter of the year we will look for this to be confirmed by better hard economic data.
Despite political fears and events, fundamental economics have been the greater influence on markets so far this year and investors have been right to “keep calm and carry on”.