Andrew Milligan, Head of Global Strategy at Standard Life Investments, talks you through the markets in the month that was September.
Political tensions and markets
On the whole, markets are coping quite well with the various political events that have made headlines recently. At the time of writing, the US stock market is up over 12% year to date. Europe and Asia are doing even better, with returns closer to 20%. This reflects the fact that global economies and businesses generally haven’t been affected by political tensions. In fact, many economists are raising their forecasts for global economic growth in 2017.
While overall forecasts look positive, it’s important to remember that individual markets are often affected by different events on a day-to-day basis. One such example that springs to mind is the pressure facing Spanish stocks and bonds after the recent Catalonia election. Tensions on the Korean peninsula also need to be monitored carefully. At Standard Life Investments, we still believe that actual conflict in Korea will be avoided due to the extremely high costs for all parties concerned, although the risk of miscalculation has certainly risen.
German coalition discussions continue
Newspaper headlines have highlighted that the hard right and hard left parties have gained a noticeable representation in the German parliament. But in truth, the ability of these parties to affect the central thrust of policy-making in Germany will remain rather limited.
Angela Merkel can form a workable coalition involving the Free Democratic Party (FDP) and Greens, together with her Christian Democratic Union (CDU) party and the Christian Social Union (CSU). The coalition may not run smoothly though, as there are some noticeable differences over matters such as energy policy, taxation and European integration; meaning it could take some time to reach an agreement that satisfies all three partners – perhaps until Christmas.
However, the implications of this coalition may be more important for the rest of the European Union than for domestic German policy. For example, the FDP has been vocal about enforcing EU fiscal rules through sanctions and a two-speed Eurozone, which is contrary to the recently expressed views of the French president, Emmanuel Macron. As far as Brexit is concerned, the time taken to form a workable coalition will limit Mrs Merkel’s involvement in negotiations between the UK and the EU.
Brexit negotiations start to provide more certainty
Financial markets are ebbing and flowing with day-to-day announcements of the cut and thrust of UK/EU negotiations. Recently there have been signals suggesting that there may be a transitional agreement, perhaps lasting several years. This provided more certainty to many UK and overseas businesses, and was one reason for the pound’s sharp jump against the dollar and euro.
Another important factor in the rise of the pound comes from hints about an interest rate increase by the Bank of England. This may be a double-edged sword though; as a stronger currency is a negative for the FTSE® 100 index. This is because the FTSE® 100 includes many overseas earners, and explains why the UK market has underperformed many of its competitors in recent weeks.
European economic outlook remains strong
The European economy certainly looks strong into 2018 – strong enough to allow the European Central Bank to start tapering its QE bond purchases and even consider raising interest rates. Germany, France and Spain are leading the way, while even Italy is seeing improved growth. This reflects a beneficial cycle of lower unemployment, better consumption and more trade.
Of course a lot of good news has already been priced into European stock markets, which are up about 20% in local currency terms due to the wave of money leaving the US and investing in European assets in 2017. Going forwards, if the euro begins to fall back against the US dollar, financial companies would benefit from higher interest rates and exporters in European countries may benefit from more support. Because of this, Europe remains one of our favoured equity markets globally as we think company profits can remain solid into 2018.
Rise in UK interest rates on the cards
As I mentioned earlier, it seems very likely that UK interest rates will rise in November. Financial markets have already largely priced this news into sterling, gilts and equities. A series of Bank of England speeches have spelled out very clearly why they’re considering taking this action:
- the global withdrawal of QE,
- the inflation threat ahead,
- the ability of the economy to withstand policy tightening.
A rise in interest rates may create an adverse effect on consumer sentiment. For many home owners, this will be the first change of interest rates since they took out their mortgage. The Bank of England has also warned about the risks from excessive amounts of unsecured loans. Going forward, many people will be looking to the Bank for guidance on whether it expects any or many interest rate increases in 2018.
The importance of China to the global economy
Looking into 2018, China remains very important for the global economy; especially emerging markets. The government has done a good job of making sure that economic growth remains above 6% a year, which has supported consumer and business confidence. However, this has been at the expense of a very sharp rise in public and private debt in recent years. Along with the UK, China’s credit rating was also downgraded in September.
An important issue for next year is whether the Communist Party will allow much more reform in parts of the economy, or whether it will rely on the debt engine to do its work for some time to come.
Trump’s presidency and the markets
I started this article by mentioning that the US stock market is up over 12% year to date. Part of this reflects the underlying economic strength of both the US and the global economy. The US is benefitting from stronger export growth to Asian and European countries. However, part of this growth reflects what Trump has done so far in his presidency, and equally, hasn’t done.
The Republicans have recently announced the outline of a large tax-cutting package. Whether and how this can get through Congress is still the subject of some debate, but the positive effects on some US firms would be quite pronounced. Other businesses, for example in the financial, health and coal industries, are benefitting from easier regulation under the Trump administration.
On the other hand, despite a lot of discussion around trade protectionism during his election campaign, President Trump has been quite cautious in this area so far. For example he has moved relatively slowly in relation to China, and over the renegotiation of the North Atlantic Free Trade Agreement (NAFTA).
Of course, other aspects of US policy-making are worrying markets; such as the tensions with North Korea and the turnover of senior staff in the White House. This may partly explain why the US dollar hasn’t been one of the more favoured currencies in 2017. Whether that changes may depend on the success of the tax-cutting plans.
So, in summary 2017 continues to be uncertain and difficult to predict. At 1825 we believe that whilst it is very important to be aware of the global political, economic and social tensions, having an enduring plan, underpinned by a measured investment strategy remains key in delivering the life of your choosing. As always, your financial planner is on hand to answer any questions you have, but do know that we remain committed to a long-term investment approach.
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. Information is based on our understanding in October 2017.