It started with an unconventional recession, one that emanated from a near collapse in the financial system but which, in some larger economies, resulted in a comparatively modest increase in unemployment. Then we had unconventional monetary policy, encompassing injections of liquidity and exceptionally low interest rates. Now we seem to be in an era of unconventional political consequences.
Electorates in many western countries are questioning the established order, as we saw in the outcome of UK referendum on EU membership, in the results of elections in the US, France and the UK, and in the general increase in support for anti-establishment political parties. There is a growing frustration that, while economies have been recovering, the benefits of growth have not been feeding through to real incomes.
The cause of this stagnation is not too hard to determine. There is a feature of the recovery that has been and remains common to most advanced economies – low productivity growth. Behind this, there has been a persistent lack of productivity-enhancing capital spending, so that although unemployment has fallen very quickly in relation to achieved growth rates, the incomes of average working people have been almost static in real terms.
The challenge facing advanced economies is to move onto a stronger investment-productivity path. Implicit within forecasts for the US economy for the past three years has been the assumption that this was imminent. Such hopes were disappointed in both 2015 and 2016, and it would seem that 2017 is set to be another year of high expectations dashed by reality. For the EU, prospects are slightly better, with momentum gradually picking up.
Reasons to be cheerful
The UK is facing additional challenges. Eventually, we believe that the Brexit process will encourage capital spending as companies with less easy access to EU labour prepare to expand into new markets. However, it may take time, particularly against the backdrop of increased political uncertainty. This is also true of the positive trade impacts that should result from the drop in the pound. More obviously, households are being tested by the inflationary consequences of higher import costs and the squeeze on real income growth.
These contrasting forces on economic activity make the likely growth rates for the UK over the next two years difficult to assess, but we believe many commentators are understating the positives.
With Japan still struggling to engender stronger core growth, the implications of current trends for advanced economies are clear: growth is set to remain dull. As a result of the more temperate expansion in demand in developed economies, emerging manufacturers, commodity producers and others that had previously thrived on exporting to the developed world will also continue to see unexciting growth.
The second quarter of 2017 has seen a further grind upwards in equity markets. European equities were the star performers in sterling terms. The US market performed well in local currency, but a weak dollar was a drag to sterling returns. The Asian and emerging markets continued their positive performance. The UK equity market was the laggard as the general election had a clear impact on sentiment.
There was a divergence in performance of different sectors, as weaker inflation and lower commodity prices caused the underperformance of financials and resources, while technology, healthcare and defensives performed very well.
Given the apparent rolling over of inflation in the US, government bond yields fell a little, giving small positive returns to investors, while high yield and investment grade credit spreads continued to narrow.
We believe that the backdrop of global growth will be positive for equities in the second half, but our neutral positioning is predicated on valuations that are no longer cheap, and our view that the central banks will begin to reverse quantitative easing. Our fixed-income positioning continues to have a preference for index-linked securities.