Capital Markets Update: February 2017

  • Trump weighs up trade options
  • US economic growth supports case for interest rate rise
  • Investors eye European election action

In a nutshell

As far as stock markets are concerned, US president Donald Trump keeps on giving – at least for now. The US economy looks to be in strong enough shape for the US Federal Reserve (Fed) to raise interest rates and the Fed Chairman, Janet Yellen, is laying down the groundwork for a rise in March. Forthcoming elections in Europe have the potential to deliver shock outcomes that could unnerve investors. Closer to home, the absence of a detailed plan for the UK to leave the European Union (EU) is adding to investor uncertainty.

Trump weighs up trade options

The Trump ‘reflation trade’, where investors are banking on the inflationary impact of the president’s expected fiscal stimulus measures, gathered pace. Trump ended the month with a seemingly well-received first address to the US Congress. The positive reaction to a more presidential Trump helped the Dow Jones Industrial Average break the 21,000 barrier. Trump’s stance on trade was more subdued than it had been, perhaps recognising the limits of what he can achieve without congressional support. The banking sector was cheered by signs of a lighter-touch approach to regulation. Greater regulatory freedom for banks would be good news for profits, but would do little for long-term financial stability. A reduced appetite for regulation in the US will be noted elsewhere and European and UK banks will be hoping the winds could change in their own regulatory jurisdictions.

US economic growth supports case for interest rate rise

The US economy continues to grow and unemployment remains very low. The Fed will be looking at these factors, which form the basis of its mandate and support the case for making interest rate rises this year. The likelihood of the Fed announcing a rate rise in March is very high.

Investors eye European election action

Investors have good reason to be wary about Brexit and elections in Europe over the coming months but is it really justified? UK Prime Minister Theresa May is due to trigger Article 50 in March, in line with her own timetable. But we are still none the wiser as to the Government’s plan, objectives or approach. The absence of detail makes it difficult for investors to know how to react.

Across Europe, a groundswell of populism threatens to provide surprising general election outcomes in the mould of Brexit and Trump’s US election victory. The Dutch kick off the election season in March. The Eurosceptic DVV party is likely to capture a good number of seats, but is unlikely to be able to form a government. Looking further ahead, all eyes are on the French presidential election, with the possibility of a victory for the National Front’s Marine Le Pen, who would hold a referendum on EU membership. An overall win for Le Pen looks unlikely, but even if she gained power there are plenty of constitutional obstacles that would make a ‘Frexit’ improbable.

In Germany, Chancellor Angela Merkel’s dominance is being challenged ahead of the election there. Her strongest rival, Social Democrat party leader Martin Schulz, may take a more forgiving line on EU membership than Merkel and this could be good for the longer-term prospects of the Eurozone. The threat to the EU’s survival may come from Italy, where an election could also take place towards the end of the year. Beppe Grillo’s populist Five Star Movement hasn’t made clear yet just how extreme its position is on Europe.

Global investment markets may react badly in the short term to any signs of right wing or populist party wins. However, even in a worst-case scenario, the break-up of the EU looks unlikely. Positive prospects for the longer term may create short-term opportunities for investors.

Outlook

Although wariness is certainly the order of the day, investors would do well to look beyond the uncertainties markets are currently facing. A lot rests on President Trump. When he submits his administration’s budget proposal in March we will know more about his tax reforms. We are alert to the precarious nature of the broader economic environment, but are also looking at short-term momentum that seems to be pushing markets upwards. As a result, we have taken a broadly neutral approach to global equities and are conscious of the need to change tack quickly if investment opportunities arise.

The UK is our least-favoured equity market and we have reduced exposure in our portfolios. Markets in the US and Europe appear more attractive. We have been defensive about bonds for some time in anticipation of rising interest rates and the Fed appears to be moving towards our point of view. We still prefer corporate bonds to government bonds, and recognise the potential for a reversal in direction should Trump prompt a flight by investors to assets that are considered safer alternatives. As a global multi asset investor, we are fortunate to have a number of options at our disposal for steering our portfolios though the inevitable ups and downs that we can expect to experience this year.

Oliver Wallin, Octopus Investments

e: owallin@octopusinvestments.com

t: +44 (0)20 7776 3153

Important information:
Personal opinions may change and should not be seen as advice or a recommendation. Issued by Octopus Investments Limited, which is authorised and regulated by the Financial Conduct Authority. Registered office: 33 Holborn, London, EC1N 2HT. Registered in England and Wales No. 03942880. Issued: March 2017. CAM04880.