11th July 2017
Brooks Macdonald: Quarterly market overview Q2 2017
US growth and inflation expectations eased slightly, partly because the president is having trouble enacting some of the pro-growth reforms he has promised, which tempered investors’ US interest rate hike expectations. Meanwhile, European and Japanese growth expectations improved and the threat of deflation in these regions has diminished. Nevertheless, both the European Central Bank (ECB) and Bank of Japan (BoJ) downgraded their inflation expectations and we expect them to keep monetary policy highly accommodative for an extended period. Ultimately, the actions of the world’s central banks are ensuring that global liquidity remains abundant.
Against this backdrop, most asset classes made gains, with equities generally outperforming bonds amid impressive nominal corporate earnings growth. The emerging markets were among the strongest performers, boosted by strengthening developed-market demand, ongoing stability in China’s economy and further weakening of the US dollar. The fact that commodity prices generally fell made the region’s equity market performance even more impressive. In particular, oil prices suffered amid renewed concerns over the effect of US shale oil production and despite the Organisation of Petroleum Exporting Countries (OPEC) cartel’s efforts to curb supply. We note that US shale oil producers’ average cost of production continues to fall and this has allowed them to increase their output, despite prices having failed to advance this year.
European equities achieved strong gains, particularly in light of the strength of the euro. The region is currently in a ‘goldilocks’ scenario characterised by accelerating growth, an improving political backdrop and supportive monetary policy. Conversely US equities lagged, although they still achieved solid gains in absolute terms, despite a number of US economic data releases missing expectations and the Federal Reserve (Fed) again raising US interest rates by 0.25%.
In the UK, the major news surrounded the Conservative Party’s decision to hold a snap election on 8 June and its subsequent failure to secure majority rule. The government also triggered Article 50 of the Lisbon Treaty and the official process of seceding from the European Union (EU) began on 19 June. Although the Conservatives ultimately managed to arrange a support agreement with Northern Ireland’s Democratic Unionist Party and continue as a minority government, the result increased UK political risk and investor uncertainty. Against this backdrop, sterling continues to trade well below its pre-referendum level, despite the UK economy having proved resilient in recent quarters. This is supporting UK inflation, which is putting pressure on real wages and consumption. Ultimately growth concerns kept the Bank of England (BoE) from changing its highly-supportive monetary policy stance.
Developments in the US ensured that the ‘reflation’ trade that occurred in the second half of 2016 continued to unwind over the quarter. Bonds generally made gains, while bond-proxy equities also performed well. Emerging market bonds outperformed the broader fixed income market, helped by the same trends underpinning the region’s equities. Meanwhile, corporates generally outperformed sovereigns.
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