Market Update - August
Slowdown in activity
Economic data in the UK has shown a broad-based slump in the immediate aftermath of the EU referendum vote. The early indicators suggest that UK economic momentum has slowed markedly across manufacturing, services and construction and there is upside inflation pressure as a result of the weak currency. We expect inflation to continue to rise, with UK CPI forecast to breach 2% in the second half of 2017. Eurozone activity has been resilient after the vote and the results of the European bank stress tests were encouraging. US economic data remains robust, although GDP growth was weaker than expected last quarter.
Rates lower for longer
In response to this slowdown in activity and in an effort to avoid recession, the Bank of England delivered a bigger-than-expected stimulus package, reducing interest rates and increasing quantitative easing. While the Bank of England faces a trade-off between inflation and stabilising activity, its stance is to tolerate a temporary period of above-target inflation. The Federal Reserve has also turned more cautious after the Brexit vote, delaying the upward trajectory of US interest rates. Futures markets are no longer looking for a rate increase in 2016, with the earliest move expected in March 2017.
Equity and bond markets have been buoyed by further injections of liquidity and a delay in normalisation of interest rates in the US. Sterling weakness has had a meaningful translational effect on the UK equity market, benefitting the large global companies in particular. With over 70% of the UK equity market earnings generated overseas, a 10% fall in sterling equates to a 7% rise in market earnings, and has driven prices upwards. We continue to believe that the bond market is overvalued, and underestimates inflationary pressures. Equities have had a strong run, and where clients need cash to fund expenditure we have used the strength to take profits. However, we are retaining our core equity allocations, as monetary policy remains supportive and valuations are not overly expensive. We expect equities to trade in a wide, volatile range and retain an exposure to absolute return approaches to dampen overall portfolio volatility. UK commercial property funds have experienced some liquidity challenges in the aftermath of the vote, however we believe they will be supported by the strong income characteristics, despite the more lacklustre capital performance anticipated.
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