For professional advisers only. Not to be relied upon by retail investors.
Capital Markets Update
- Monetary and fiscal policies look set to change
- Europe: Brexit softening and Macron’s reform
- Cautious outlook continues
In a nutshell
June gave investors plenty to think about from a policy perspective. The main focus fell on the likely direction of monetary policy set by central banks, and on government fiscal measures aimed at stimulating economic growth. In Europe, there was little for investors to glean from either the ongoing Brexit negotiations or new French President Emmanuel Macron’s planned reforms. In the US, continued vagueness about President Donald Trump’s promised tax reforms added to market uncertainty.
Governments flex policy muscles
Markets have been in thrall to monetary policy, particularly interest rates, since the financial crisis of 2008. During that time, governments have followed a path of austerity – measures aimed at tightening government expenditure. However, we are now starting to see an important shift in direction for both monetary and fiscal policy. This is being led by the US, where President Trump has outlined a plan for large-scale fiscal stimulus measures, including tax breaks and infrastructure spending. The UK general election result has been interpreted as revealing an electorate that is tiring of austerity measures, and the Government is likely to take heed. Fiscal policy appears to be back on the table and Chancellor Philip Hammond’s November budget may prove to be the showcase marking the end of austerity politics.
Central banks signal end to easing
Central banks are adopting a more hawkish tone by signalling to markets that the conditions are right to start tightening monetary policy. This is quite clear in the US where the US Federal Reserve (Fed), is already tightening by steadily increasing interest rates. It is perhaps more subtle in Europe, where European Central Bank President Mario Draghi spooked markets a little this month in an upbeat speech where he pointed to a broad economic recovery in the region. The tone of his speech prompted a rise in the euro as markets interpreted it as a signal – both for scaling back QE and possible interest rate rises. This proved to be premature. Draghi had pointed out that there would be no change in current policy, but his tone has changed and that’s important to markets, particularly those hooked on QE. In the UK, Bank of England Governor Carney stated that now was not the time to raise rates or change policy.
Europe: Brexit softening and Macron’s reform
There was little for investors to glean from political events on either side of the English Channel. The hung parliament that followed the UK general election appeared to increase the chances of alternatives to the ‘hard’ Brexit scenario, but in our view the balance of probability still lies with the Government sticking to its original plan. Pro-European French president Emmanuel Macron’s party won the National Assembly elections, but on a very low voter turnout. This points to a latent threat of possible unrest among the French electorate. We’ll be watching Macron’s attempts at labour reform with interest.
US: facing a taxing time
At the moment, it seems the market has lowered expectations on the scale of fiscal stimulus expected from Trump’s presidency. That is illustrated by the steady decline in share prices for infrastructure companies and companies that pay a larger tax bill relative to others in the S&P 500 Index. The initial euphoria following Trump’s presidential election win had identified these types of companies as key beneficiaries of his presidency and rewarded them with huge share price spikes. Tax reform is expected to happen, after all it’s the bread and butter of Republican Party policy. But whether it will be on the scale that Trump has envisaged (and promised) remains to be seen. Some dilution of his tax reform is inevitable.
Boost for Chinese stocks
Elsewhere, June saw Chinese A class shares join the MSCI World Index for the first time. This boosted selected Chinese stocks and the broader emerging markets. The region has performed well recently and against expectations, given the anticipated effects of a strengthening dollar and Trump’s protectionist policies.
The oil price continued to be put under pressure from excess supply and it remained at the lower end of its short-term trading range. The Organization of the Petroleum Exporting Countries (OPEC) has attempted to restrict supply but its members are yet to take heed. The demand is still there so, if OPEC is successful, we should see oil prices move higher.
Market volatility does not appear to be as high as might have been expected, given all that is going on. Despite uncertainty, the Chicago Board Options Exchange (CBOE) Volatility Index, a popular reference for market volatility, remains at historic lows. We remain cautious given the political uncertainty and room for policy error from both government and central banks. However, the dynamic between loosening fiscal and accommodative monetary policy could provide short-term investment opportunities. Global economic growth is feeding through to markets and that is a positive for investors.
The UK remains our least favoured region. Sterling has been significantly weakened in the wake of Brexit. Although this has proved beneficial to exporters and companies with overseas earnings (the FTSE100 Index being a winner), the downside has been imported inflation that will ultimately lead to rising prices and eventually hit the pockets of consumers. In Europe, as political stability begins to take hold, the focus will turn to the rate of economic progress which is enjoying a tailwind. The US equity market has acted more cautiously on Trump’s fiscal policy, which should offer some investment potential if he manages to cause a surprise. The current trajectory for rate rises in the US will not be good for bond prices, but fear of policy error from the Fed or Trump may keep prices high and yields low for a while longer. We prefer corporate debt to government bonds and bonds with shorter maturities – which helps to reduce our portfolios’ exposure to interest rate changes.
Oliver Wallin, Octopus Investments
t: +44 (0)20 7776 3153
For professional advisers only. Not to be relied upon by retail investors. The value of an investment, and any income from it, can fall or rise. Investors may not get back the full amount they invest. Past performance is not a reliable indicator of future results. 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: July 2017. CAM05362.