Andrew Milligan, from 1825, takes a look at the markets in the month that was February.
Spring has sprung and political uncertainty in Europe continues to make the headlines. But what does this mean for UK investors? In this month’s market review, I look back at the state of the markets in February 2017 and consider the opportunities and challenges that lie ahead in the coming months.
February 2017 dominated by political headlines
The political backdrop in Europe remains highly uncertain. On top of elections in the Netherlands, France and Germany, the outlook also remains rather uncertain in Italy and Greece. And as well as complicated negotiations between the UK and the rest of the EU over Brexit, extra political uncertainty could come in the shape of another Scottish referendum which many commentators regard as increasingly likely.
In addition to the rise of populism in Europe and concerns over the response by governments to immigration, there are broader questions to be asked about Europe’s relations with Russia, or China’s relations with the USA. The net result is likely to be less confident investors and more volatile currency movements.
At Standard life Investments, we look at the economic fundamentals and assess how they stand alongside the political risk that’s priced into markets. With all of this in mind, we keep moderate levels of risk in our portfolios and remain slightly underweight on sterling as we believe it may have further to fall.
The US stock market and recent all-time highs – can this strong performance continue?
The US stock market has recently reached all-time highs and we consider it to be well supported by a sustainable upturn in the economy. Furthermore, the outlook for corporate profits could be helped significantly by tax, spending and deregulation decisions by the Trump Administration, which appears very business friendly. As a result, in the short term we’re still overweight on the US stock market.
However, there are dark clouds on the horizon. The faster the economy grows, the more likely that higher inflation will force the Federal Reserve (the Fed) to raise interest rates. And the faster that capital flows into the US market, so the dollar will rise, meaning that many firms will face competitive pressures. If wages grow more quickly as a result of rising inflation and falling unemployment, but without any accompanying higher productivity, we would begin to see a squeeze on company margins.
Whether later this year, or next, we may well move away from US assets into other markets – but at the moment we remain overweight. The fundamentals will determine when.
The Federal Reserve and impending rate rises
The Fed has indeed offered guidance on impending rate rises and, as a result, the market expects it to raise interest rates three times this year. This will probably start in March, as economic growth and inflation picks up. The expectation is for there to be a further three or four moves in 2018. This is largely because unemployment is expected to decline further, leading to more rapid growth in wages.
The main area of uncertainty is around President Trump’s plans for tax cuts, defence and infrastructure spending increases, as well as potentially sizeable deregulation in many areas such as environmental policies – all of which could support future growth. On some estimates the US government could push a stimulus package worth $1 trillion through Congress to support their plans; however there are many political obstacles along the way.
A second area of uncertainty is how aggressive or cautious the Fed will be in its response to the Trump Administration’s plans. This may partly depend on the appointments which the President can make to the Fed over the next 18 months or so.
Most of that story is already priced into markets, but as ever politicians and the Fed like to surprise!
Gilt yield lows of 2016 – are the headwinds still to come?
Many one-off factors encouraged a dash into safe haven assets such as bonds in 2016 and we think that yields in the gilt market did reach their low point last year.
Looking ahead though, there are both positives and negatives for bonds – an increase in inflation, political uncertainty in the UK and Europe, and the modest improvement in public sector finances are just a few.
In the short term we expect higher gilt yields, not only because of developments in the UK, but also due to the backdrop of higher US bond yields as the Fed takes measures to stop the economy growing too quickly and to curb inflation. However, any upward moves in yields need to be put into context. As the Bank of England has made very clear, even when it starts to raise interest rates, it doesn’t expect to see a return to anything like pre-2008 levels.
It’s key to note that there are still many structural issues having an impact on growth and inflation – in the UK and globally. As such, a long standing world of low interest rates remains as important a consideration as ever for investors.
What opportunities lie ahead?
In the short term, we like most equity markets around the world, just less so than the US. Europe and Japan are supported by a recovery in their economies and the benefits of a lower currency relative to the dollar, which helps company profits.
At Standard Life Investments, we also have a modest overweight position in emerging markets, although this is very much on a region by region or country by country basis. The economic situations are getting better, for example, in large economies such as Brazil and India, while China looks set fair for solid growth this year. But a large number of political flash points surround many emerging market economies too.
At the end of the day, a sharp rise in the US dollar and/or higher US interest rates aren’t historically a good backdrop for emerging markets.
So, modest levels of risk in our funds, looking for a mix of growth and income opportunities, aware of the economic upturn but well aware of the political and geopolitical risks.
If you have any questions about your investment strategy, your 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 up or down, and may be worth less than you paid in.