Capital Markets Update: April 2017

There was plenty of political news in April for investors to absorb. In France, two outsiders are jostling for the country’s presidency. In the UK, a snap general election announcement added to the uncertainty of exiting the European Union (EU). On the international stage, US President Donald Trump acted tough in Syria and talked tough on North Korea. He also unveiled plans for significant tax reforms. The only constant at the moment appears to be change, and although markets don’t like uncertainty, they seemed to hold up relatively well.

Markets soothed by Macron’s progress

The first round of France’s presidential election saw pro-European centrist Emmanuel Macron and the Front National’s Marine Le Pen progress through to a final run-off. The candidates lack any meaningful political experience and neither party has any presence of note in the French parliament (Front National has only two MPs and Macron’s En Marche has none). Whoever becomes president is going to find implementing their agenda tough going. Even if Le Pen achieves an unlikely victory, her anti-EU stance probably won’t lead to France exiting the EU. Markets reacted favourably to Macron’s first-round win, with both share prices and the euro rising in value.

The German election in September appears to hold fewer concerns for investors. Unfortunately, attention could once again switch to Greece’s economy. The country has enjoyed a period out of the spotlight as a consequence of the busy European political calendar. However, Greece continues to struggle to meet its debt obligations. The ongoing difference of opinion between the country’s two main creditors, the International Monetary Fund and Germany, will soon need to be resolved. Greece appears to be taking positive steps and, as a result, will most likely be supported for the time being.

It’s June for May’s general election

Prime Minister Theresa May announced a snap general election for 8 June, citing the need to strengthen her hand in the Brexit negotiations. However, the election looks more like an opportunity to increase the Conservatives’ majority in the House of Commons, while allowing the Prime Minister to replace the party’s current manifesto with her own agenda. Brexit is clearly the defining issue. However, there has been little or no view on what a Conservative domestic agenda under May might look like.

Tactical Trump manoeuvres on foreign diplomacy and US tax cuts

Donald Trump’s pragmatism came to the fore with what looked like a shift in his foreign policy position. This was evident from the US air strike in Syria and sabre-rattling with North Korea. On the domestic front, the Trump administration outlined its broad principles for tax reform. Investors are looking for big changes to the tax regime in line with the president’s election campaign rhetoric. The announcement was short on detail, and tax reforms require approval in both Congress and the Senate, so the submission is likely to be diluted. Trump’s emphasis appears to be on stimulating short-term economic growth at the expense of the federal deficit. The proposals are based on the belief that subsequent economic growth arising from tax reform will compensate for the short-term negative impact on federal finances resulting from reduced tax revenues. Market reaction was muted, mainly because there was little detail to go on, but even a benign reaction was a good one in a market that is expecting quite a lot from Trump.

Outlook

We remain cautious, given the current political uncertainty. Should the Conservatives win the general election, it is still difficult to see how an enhanced majority would strengthen the UK’s hand in Brexit negotiations. The topic of Brexit will dominate the election campaign, but we will also be looking for details on the domestic agenda. Tax rises in the UK are likely and this would put further pressure on consumers, who are already starting to feel the pinch from higher prices caused by a weak sterling. The UK looks to be the least attractive developed equity market at the moment. A win for Emmanuel Macron in France’s presidential election should prove a boost to European equities, as it would point towards a more stable EU. It would also reduce concerns over a destabilising wave of populism across Europe and turn attention away from politics to economic issues. The Italian election is due but, even if it happens this year, there seems to be little appetite among political parties to withdraw from the EU.

The prospects for US equities, which have enjoyed an upbeat earnings reporting season, would be supported by further economic stimulus from Trump’s proposed tax reform. We will pay close attention to how the tax reform bill develops on its way through Congress and the Senate. If Trump gets it right, we may see a continued boost for US equities, particularly as investors appear to be waiting to see what shape tax reform takes. We are also looking more favourably on global emerging markets, which have held up well since Trump’s election win. Bonds, and US government bonds in particular, remain vulnerable to higher interest rates and the anticipated inflationary consequences of Trump’s administration. Current political uncertainty has held back bond yields as investors opt for relatively safer, lower-yielding bonds. But that situation could change quite quickly.

Oliver Wallin, Octopus Investments

e: owallin@octopusinvestments.com

t: +44 (0)20 7776 3153

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