Market Update - May
Global growth downgrades
As Christine Lagarde, Managing Director of the International Monetary Fund, said last month, 'The good news is that the recovery continues: we have growth; we are not in a crisis. The not-so-good news is that the recovery remains too slow, too fragile, and risks to its durability are increasing.' In what has become an annual ritual, the IMF downgraded its expectations for global growth in its spring forecasts. Markets received this news with equanimity as most economists had already downgraded their forecasts.
However, it's not all bad news. Commodity prices have been firmer: the oil price has rallied and industrial metals have shown signs of life. Economic indices such as the purchasing managers and the US Institute for Supply Management (ISM) have shown evidence of an upturn. We do not expect a recession in the US, or a hard landing in China, but agree with the IMF that the fragility of the recovery merits care.
Brexit uncertainties add volatility
As the EU referendum approaches, the vote is a hot topic of conversation. Although polls indicate that the result is finely balanced, the betting markets are more confident, pricing only a 30% chance of a 'leave' vote. The long term economic impact of a 'Brexit', should it occur, is largely unknown as it would be dependent on trade negotiations, but in the short term we expect a leave vote to dent UK GDP by around 1% by the end of 2017. This would likely be accompanied by significant sterling weakness and a resultant pick up in inflation. UK markets would likely react negatively, with mid and small cap more affected (less overseas earnings) than the larger companies, and property and financial sectors most exposed. The outlook for interest rates is conflicted, on one hand interest rates should be reduced to stimulate growth, whereas inflation and currency weakness would suggest an increase in rates. Global markets are less dependent on the outcome of the vote, with the timing of US interest rate increases arguably more significant.
We expect to see the volatility in equity markets continue, particularly in domestic markets ahead of the referendum. Equity markets are not expensive in general, but we are becoming more cautious as the outlook for earnings growth is deteriorating. The market rotation this year continues, and we have a slight bias towards value approaches. Bond markets remain overvalued on a fundamental basis in our opinion, as we do not expect deflation, and as such we prefer to diversify into alternative assets such as absolute return. Income diversifiers such as property and infrastructure are also useful additions to portfolios where appropriate. Cash returns remain very low, but we seek to use cash positions in the current volatile environment to take advantage of any opportunities.
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