The Big Picture: economic and political summary for July from QuotedData
Every month here at QuotedData, the investment trust analysts collate the insights on markets and economics taken from comments made by chairmen and managers of investment companies investing across the globe. We organise these to highlight what the sector’s trusts believe are the factors relevant to performance in their particular geography or industry sector.
The tit-for-tat imposition of tariffs on imports by the US, EU and China unnerved markets in June. Emerging markets were particularly weak, the MSCI Emerging Market Index fell by 3.9% over the month. Chinese markets were hit by falls in the value of large, highlyrated technology stocks. In Europe, nerves were set on edge in May by the Italian political situation. This seems to have resulted in a flight to German bunds, whose yields fell sharply over the month.
Uncertainty persists but some investors believe that it is uncovering opportunities.
The managers of global and multi-asset funds all appear to agree that the world economy has come to the final phase of the economic cycle that followed the global financial crisis of 2008. Many see the macroeconomic environment as very hard to call; rising interest rates, high valuations, political risks are creating uncertainty.
The managers of Capital Gearing Trust warn that equities and bonds currently trade at such high valuations that medium term returns are likely to be lower than those enjoyed historically, and in a number of cases negative after adjusting for inflation. James Ferguson, chairman of Monks, raises elevated valuations as one of the chief concerns currently facing markets. On the other hand, there appears to be an abundance of growth opportunities from across a range of economies and new and fast changing technologies.
James Long, chairman of Aberdeen Diversified Income and Growth Trust, agrees adding that, although valuation levels tend to drive equity market returns over the medium to long term (3 to 10 years), in the short term (less than 12 months) macroeconomic conditions can be the more important driver.
The investment management team of Personal Assets Trust write that, notwithstanding the recent market falls, investor confidence remains high, sentiment strong and the economic outlook stable. They stress that the problem is that valuations by historical standards are even higher while geopolitical risks and the threat of greater protectionism have increased.
Brexit still hangs over the UK economy and high valuations hang over the market
Most of the chairmen of UK Equity companies that reported in June, commented on Brexit.
Roger Cuming, chairman of Montanaro UK Smaller Companies, believes that there are currently more reasons for caution than usual but agrees with the sentiment expressed by many that, long term, there are opportunities in under-recognised quality growth companies.
Robert Robertson, chairman of Lowland, expects the UK economy to continue to grow, albeit more slowly than Europe or the US. There are, he writes, commentators who believe it will slow further due to concerns about Brexit, which may limit the free movement of goods and people. However, he stresses, as do many in this report, the importance of seeing the macroeconomic picture as a back drop to the business of investing in individual companies, rather than the overarching factor.
The investment managers of BlackRock Income & Growth see the outlook for the UK economy is more uncertain given ongoing Brexit negotiations in contrast to the growth seen elsewhere. However, they believe these Brexit fears have created the opportunity to own high quality franchises at attractive valuations. They point out that the UK is a hugely international market and that it is supported by very strong corporate governance, shareholder interaction, regulation, tax and accounting laws and transparency. This makes the UK market attractive for investing in high quality companies with both domestic and international exposure.
Cautious optimism from Asian investors, despite looming trade wars
The chairman and investment managers that reported in June all sound a note of cautious optimism. Politically, there is increasing stability in the region, although issues that have yet to be addressed, such as China’s actions in the South China Sea, remain.
Whilst there is concern about the possible trade war with the US, many commentators point to the robust nature of corporate earnings and the domestic growth story that remains in Asia.
Unlike other companies in this report, Ian Hargreaves, who is the manager of Invesco Asia Trust, doesn’t see the valuation of Asian companies as stretched. The managers of Aberdeen New Dawn say that, while the global economy continues to expand at a steady pace, the risks to inflation from the imposition of trade tariffs, higher interest rates, and rising commodity prices are creating uncertainties for Asian markets in the near term. However, Nicholas Smith, chairman of Schroder AsiaPacific Fund, writes that he accepts that there are undeniable challenges to all equity investments at the moment, but is struck when talking with their managers by how excited they are by the opportunities at an individual stock level.
Although European economic growth is not accelerating, it remains at a healthy level
Two JPMorgan funds reported in June; JPMorgan European Smaller Companies and JPMorgan European. The views of the management teams are unsurprisingly similar. The managers of JPMorgan European Smaller Companies pose the question that, with persistent fears surrounding the pace of central bank tightening and its potentially negative impact on economic growth, there is uncertainty as to whether we have reached the end of the bull market or if this is a correction within a rising market.
They believe that this cycle should be different as the deflationary effect of technological progress across all industries should contain inflationary pressures. This is supported by the fact that, while many companies are warning of rising input costs, unit labour costs in the US are not rising. They suggest that, if correct, this should limit ten-year bond yields to below their long-term average, the level at which interest rates have historically began to have a negative impact on asset prices.
Although economic growth is no longer accelerating, due to the rise in bond yields, it remains at a healthy level.
A benign US economic growth scenario needs watching for signs of overheating
Andrew Bell, chairman of Gabelli Value Plus+, paints a somewhat benign picture of the US economy. Early enthusiasm in 2018 gave way to concerns of rising inflation, which might in turn prompt central banks to increase interest rates by more than expected.
Nevertheless, so far there are only limited signs that the benign period of low inflation is under threat. Simon Miller, chairman of Blackrock North American Income, notes that most leading economic indicators show continuing strength in the U.S. economy. This is supported by tax cuts and government expenditure plans. However, he also sees risks from rising inflation and increased tensions in trade relations, together with possible interest rate hikes.
The base case of the managers of Blackrock North American Income is for a continuation of the current U.S. economic expansion. However, they are monitoring inflation and interest rates for signs of economic overheating. These factors can potentially pull forward the end of the current business cycle more quickly. They are also watching U.S. protectionism regarding global trade and tariffs.
However, as do many, they do not see the trade actions implemented so far as derailing the benign economic and market backdrop, although further escalation could impact investor sentiment and expectations for economic growth.
Japanese monetary policy remains supportive of economic growth
Harry Wells, chairman of CC Japan Income & Growth believes, that Japanese monetary policy remains supportive of economic growth while interest rates in Japan are likely to remain near zero, against a background of persistently low inflation.
Alan Clifton, chairman of JPMorgan Japan Smaller Companies, notes that expectations for GDP growth in Japan remain high with improving demand, both domestically and from overseas. The economy shows little evidence of strain. The key risks for Japan are geo-political tensions, potential trade protectionism in the US and a faster than expected slowdown in China. The investment managers believe that global economic growth will continue to expand at a healthy rate.
Emerging market participants are watching development of US protectionism very closely
Chetan Sehgal, manager of Templeton Emerging Markets, believes that emerging market economies look poised for further growth. He gives the International Monetary Fund estimate of 4.9% GDP growth for emerging markets in 2018 as an example (up from 4.7% in 2017). They are also watching how the US trade protectionist policy plays out and its impact on the synchronised global growth that has lifted stock markets.
Templeton Emerging Markets are upbeat about Asia, the investment opportunities present in markets from China to Indonesia, and see more opportunities in Brazil and South Africa. Sounding a note of caution, Mark Hadsley-Chaplin, chairman of Aberdeen Emerging Markets, notes that further interest rate rises are expected in the US in 2018, and the implications of this, the strength of the US Dollar, as well as a number of ongoing political tensions could have an impact on equity markets. He expects economic growth across emerging markets to be slow but should remain at a reasonable level. Inflation is, in general, manageable despite the increase in energy prices.
In China, economic growth remains above 6% and the most recent news from both China and Korea suggests that President Trump’s appetite for international contretemps may be less than feared, and that his unorthodox methods may actually reap diplomatic dividends as he creates a dialogue were others have feared to tread.
There are challenges for the Indian economy
Richard Burns, the chairman of JPMorgan Indian, notes that India’s economy has been growing more rapidly in 2018 than it did in 2017. The investment managers of Aberdeen New India believe that the country faces several challenges in the near term. Inflation, while still under control, could accelerate, which would translate into cost pressures that erode companies’ profits, and possible rate-hikes by the central bank. Global concerns of faster monetary policy normalisation and an intensifying trade war could also hurt sentiment. Elections, due no later than May 2019, are adding to the uncertainty.
Even the lowest estimates of China’s forecast economic growth are more than developed markets
Even the lowest estimates of China’s forecast economic growth are in excess of the developed markets in the West, writes Nicholas Bull, chairman, Fidelity China Special Situations. Dale Nichols, the portfolio manager, is also highly positive. He notes however, that challenges remain, with debt growth still outpacing overall growth in the economy. He expects the pace of economic growth to slow due to the impact of reform and efforts to slow credit growth.
Geopolitical tensions persist whilst the Russian economy continues to grow
The chairman of JPMorgan Russian Securities, Gill Nott, comments that despite the geopolitical tensions that surround it, the Russian economy continues to grow. The managers, Oleg I. Biryulyov and Habib Saikaly agree, noting that the country has an improving domestic economy, backed by earnings growth, lower level of inflation and rising commodity prices. Additionally, the domestic political outlook is stable following recent presidential elections.
The retail sector continues to bite; Brexit makes clarity less easy
David Hunter, independent chairman of Custodian REIT reports that the economic conditions in the UK property market have slowed them down in their day to day activity. However, Nicholas Thompson, chairman of Picton Property Income, maintains a positive outlook, as from an economic perspective, they are focused away from the retail market on industrial sectors, where there is growth.
Mark Burton, chairman of AEW UK REIT, comments that prospects continue to be dominated by Brexit negotiations, although it seems that some progress has been made towards arriving at a trade deal. The ultimate outcome remains unknown, and it remains difficult to assess the impact on the UK commercial property market. With regards to the European property sector, Sir Julian Berney, chairman of Schroder European Real Estate, reports growth in European industrial and retail property, supported by positive economic activity
Infrastructure – Renewable Energy
Solar readies itself for subsidy free generation
Kevin Lyon, chairman of NextEnergy Solar Fund, comments that when subsidies dried up for renewables in the UK, there was a slowdown in activity in the solar industry. This looks set to change. Solar is one of the fastest growing sectors driven by falling costs and the need for low or no carbon energy generation is required.
The industry is now positioning itself for a new phase in which subsidy-free solar assets will be built in the UK. John Laing Environmental Assets notes that it will take some time for the exact details of arrangements post-exit from the EU to emerge. However, government policy commitments for clean energy continue in the UK and climate change remains one of the important areas of focus, not only for the UK, but globally. As an EU member, the UK is required to generate 15% of its energy from renewables by 2020 under the European Union’s Renewable Energy Directive.
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