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Mixed messages

04 July 2017

Global stocks reflected shifting expectations for the US economy, UK politics, interest rates and eurozone growth, says CIO Chris Ralph.

For those investors who like to focus on politics and geography, the second quarter offered a series of significant turnarounds.

Those same shifts made themselves felt on markets, not least as large-cap UK stocks lost ground to their peers in Continental Europe. Politics, economics and concerns over US valuations all appeared to play their part in the change in mood.

The quarter opened just three days after the prime minister triggered Article 50 of the Treaty on European Union – in retrospect, the three weeks between that point and the calling of the general election appear to have been ‘Peak May’. From there, it was largely a downhill journey, as her party forfeited its parliamentary majority, and she was left a diminished figure; although, in relative terms, UKIP and the SNP suffered heavier electoral losses. Politics aside, it was a grim period for the UK more generally, due to a series of terror attacks and the Grenfell Tower tragedy in June.

Economic indicators offered little to celebrate, as figures showed that a services slowdown had pushed the UK’s first-quarter growth down to just 0.2%, the lowest of all 28 EU member states1. Jobs and manufacturing numbers provided encouragement, and the more domestically-oriented FTSE 250 rose 2.7%, breaking 20,000 for the first time ever. But ONS figures showed that inflation reached 2.9% by quarter-end, while the more dominant FTSE 100 rose by less than 0.4%.

Unfortunately for workers, wages barely even gave chase to inflation, falling to their lowest level in real terms for three years – the current decade is set to be the worst for UK real wage growth since the Napoleonic Wars, according to the Institute for Fiscal Studies. This may go some way to explaining why the household savings rate slipped to a 50-year low2. It also poses a challenge to the Bank of England’s Monetary Policy Committee, whose members offered conflicting signals of the rates outlook, but ended the quarter sounding more hawkish than they had when it began.

While the Bank of England wavered, the Federal Reserve plotted a more determined course, raising rates by a quarter point and forecasting a further rise later in the year. In fact, US inflation had once more dipped just below 2% by quarter-end, and GDP growth in the first quarter was disappointing, while consumption fell to its lowest level since 2009. Even so, the Fed warned that US household debt had reached its highest level since the global financial crisis.

After a tough start to the quarter, the S&P 500 ended up 2.7%. The technology sector was a particularly strong performer, pushing the tech-heavy NASDAQ above 6,000 for the first time in its history, while Apple became the first listed company to top $800 billion in value. The US index also benefited more broadly from a buoyant corporate earnings season – one that was not limited to the US. In Japan, where business confidence struck a three-year high, the Nikkei 225 rose by more than 5%.

Nevertheless, politics continued to set nerves jangling, as the US president sacked the head of the FBI, pulled the US out of the Paris Agreement on climate change, and pledged to impose tariffs on imported Chinese steel.

Despite such extreme outcomes, volatility (as measured by the VIX) refused to depart from its extended lows for long. Moreover, while US and UK indicators gave investors pause, the eurozone found a new gear. Its growth rate surpassed both countries, and its unemployment level struck an eight-year low thanks to its fastest hiring rate since the crisis. Eurozone business confidence ended the quarter at an extended high.

However important the structural tailwinds for the eurozone, the considerable market upswing owed perhaps even more to one man: Emmanuel Macron. Having formed a new political party little more than a year earlier, the 39-year-old won the French presidency and his party dominated the legislative elections, giving the Europhile centrist an exceptional mandate to carry out his reform programme. French stocks rose quickly in the wake of his victory although the broader Eurofirst 300 rose by a more measured 1.1% over the period. In late June, Mario Draghi gently indicated that the ECB’s quantitative easing programme might soon begin to taper.

Meanwhile, EU exit negotiations finally began as David Davis met with Michel Barnier in Brussels. The UK dropped its request to negotiate trade alongside the exit bill, instead acquiescing to EU ‘sequencing’ demands. Meanwhile the UK chancellor, emboldened by Theresa May’s poor showing at the polls, offered signs that the ‘hard Brexit’ touted in electioneering might yet be softened somewhat – and that business would henceforth enjoy a louder voice in Downing Street.

1 http://ec.europa.eu/newsroom/ecfin/newsletter-specific-archive-issue.cfm?newsletter_service_id=199

2 https://www.ons.gov.uk/economy/nationalaccounts/uksectoraccounts/bulletins/quarterlysectoraccounts/jantomar2017

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