March 2018 market update

Market review – interest rates and opportunities

Andrew Milligan photo

In this month’s market review I look at what’s driving global markets and what’s next for interest rates and the pound. I also consider the outlook for Europe, Trump’s tax reforms and the opportunities in emerging markets.


Markets regain ground

Global stock markets have generally regained much of the ground lost in the sell-off at the end of January and the start of February. As ever, there are a few exceptions and sadly the UK is included. It’s worth noting though that the recent volatility spike was quite unusual given it was limited to equities, with bonds and currencies hardly affected. It also wasn’t severe or prolonged enough to materially affect global growth.

Looking ahead, there’s undoubtedly debate about the outlook for stock markets. On one side there are some concerns about higher interest rates, company valuations and continued political tensions. But on the other, company profits are strong and analysts are upgrading estimates for future growth based on upbeat economic data and leading indicators. As a result, at Standard Life Investments we’re moderately overweight on global equities.


UK interest rates look to be on the move

The UK market is paying very close attention to statements from Monetary Policy Committee (MPC) members. This follows an indication from the Bank of England that the pace of interest rate increases could accelerate if the economy remains on its current track.

Economic data clearly support some rate moves, as there are still upward pressures on inflation from tighter labour markets. With that in mind, the MPC is expected to raise rates twice this year, in May and November, although a number of factors could lead the MPC to change its mind – currency volatility and Brexit being just two. Taking valuations into account, our portfolios are broadly neutral on UK gilts.


What does the Fed have in store?

The money markets have priced in an interest rate increase at the March meeting of the US central bank. But investors are looking further ahead, and questioning whether there will be three or even four rate moves this year.

What is clear is that it no longer matters whether Ms Yellen or Mr Powell is chair of the Fed – the committee is updating its forecasts, its messages to the markets, and investors are responding.

On top of the underlying strength of the US economy, there’s considerable discussion about the full extent of the tax cuts and spending increases passed by the Trump Administration and Congress in recent weeks. With that in mind, economists are busy raising their forecasts for economic growth in the US in 2018 and 2019 towards 2.75%, even 3%. That will keep the US bond market under pressure.

Given these prospects of stronger US growth, we now expect up to eight hikes over the next two years, around double the pace currently priced into markets. This will be quite different to the more gradual adjustment still anticipated in other developed markets, such as the Eurozone and Japan. During this time it will be important to keep a close eye on the performance of the dollar.


What is the pound telling us?

I’ve recently been asked if the pound’s continued recovery shows resilience in the face of Brexit uncertainty. The truth is it’s a very difficult question to answer. Currency markets can be quite fickle.

Sometimes they’re focused on economic fundamentals, for example whether the UK economy is strong enough to encourage the Bank of England to curb inflation by raising interest rates. But other times currency markets are more focused on politics, whether that’s government issues in general or more specific issues like Brexit. On balance we are slightly underweight sterling in our funds.


Brexit and the European Union

Despite complex Brexit negotiations and the UK’s upcoming departure from the European Union (EU), there doesn’t appear to be a significant negative impact on Europe’s economic performance. While the UK economy has certainly slowed since the Brexit referendum, the effect on the European economy has been more than offset by two other factors.

One is the upturn in global trade and manufacturing activity in recent months – for example Germany benefits a lot from Chinese demand. The second is a virtuous circle; as unemployment comes down across Europe so consumer confidence and spending starts to rise. Indeed one of the reasons why many EU citizens recently living in the UK have returned home is that it’s easier to get a job there.

Looking ahead, our outlook for Europe is positive. The Eurozone upswing only shows modest signs of cooling in early 2018 and there are clear signs of strong growth delivering rapid job creation and lower unemployment.


Opportunities in emerging markets

At Standard Life Investments, we like emerging market assets – both equities and, to a lesser extent, bonds. We’re seeing economists raising their estimates for North America and Europe, with only a moderate slowdown expected in China. This economic backdrop supports emerging market exporters.

There are some imbalances of course. Industrial production in the region has been growing more slowly than in developed markets while credit growth continues to decelerate. But, in the main, the debt levels and current account positions of most of the larger emerging market countries are quite sustainable.

In a world of low interest rates, the attractions of higher yielding emerging market debt are also apparent. Of course, if President Trump launches a trade war, then all bets are off! At present though we think it more likely that his new tariff announcements will remain focused so the US economy and financial markets aren’t too negatively affected.


If you have any questions about your investment strategy, your 1825 Financial Planner will be happy to help.


The information in this blog or any response to comments should not be regarded as financial advice. Please remember that the value of your investment can go down as well as up and may be worth less than you paid in. Information is based on our understanding in March 2018.


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