The Multi-Asset Process

June 2017 market review

June was dominated by what turned out to be a fairly chaotic election in the UK, which – if anyone still needs it after the last 12 months – again reinforced the futility of political predictions.

While there remains plenty of uncertainty about how the minority government will function, we can draw a few conclusions from the events of 8 June. The result was a kick in the teeth for the Conservatives: while they called the election expecting a stronger mandate for Brexit negotiations, the nation voted along traditional lines of public services and taxation.

There is little more clarity on Brexit than pre-election but with exit negotiations now begun in earnest, we look to have a weaker hand with the Conservatives propped up by the DUP. As also happened post-Brexit, political uncertainty has shown up largest in the liquid capital markets of sterling and government bonds, and the weaker currency in the UK means inflation could well prove persistent.

As for equities, politics once again had little lasting impact on sentiment: while the market was not expecting a hung Parliament, it appeared prepared for such an outcome and after an immediate dip, the FTSE 100 was back above the 7500 level a few days later and remained above 7300 by month end despite falls after the FCA’s report on the asset management industry.

Against this however, there are growing concerns about how far the bull market can continue. Bank of America Merrill Lynch's latest monthly Global Fund Manager Survey, conducted in early June, revealed 44% of managers taking a cautious stance on global equities, up from 37% in May, with 84% identifying the US as the most overvalued region for stocks.

Moving to America, we saw the Federal Reserve raise rates again in June, the second hike so far this year but still just the fourth since the financial crisis. US officials maintained their projection of one more rise in 2017 amid slightly stronger growth projections and downward revisions to its unemployment forecasts after the jobless rate fell to a 16-year low in May.

Again, this rise was widely anticipated and priced in and by delivering two hikes in the first half of the year, the Fed looks to have bought itself some flexibility over further policy normalisation. The most recent Federal Open Market Committee minutes outlined its plans to begin a slow reduction of its balance sheet this year and we will watch how this affects the economy and equity market with interest.

While US policymakers look uniform in their decisions, minutes from the Monetary Policy Committee’s (MPC) June meeting highlight a deepening rift. Once again, the decision in June was to leave rates on hold but the BoE’s chief economist revealed he considered opposing Governor Mark Carney and voting for a rate rise.

Carney cited Brexit uncertainty as justification for leaving rates on hold at 0.25%, but just hours later, economist Andy Haldane said it would be prudent to tighten policy before the end of the year.

The June meeting of the MPC resulted in a 5-3 vote in favour of leaving rates on hold, with both the governor and economist voting with the majority. But Haldane, previously one of the most dovish members of the committee, said the balance of risks had shifted so the dangers of moving too late outweighed those of raising interest rates too soon. Late in month, Carney also admitted rate rises may be necessary if business investment increases.

What might higher interest rates – and receding quantitative easing (QE) – mean for investors over the rest of 2017 and beyond?

Over recent months, bond markets have largely been in a deflationary mindset while equities – buoyed by Trump’s election – have been more geared towards reflation. When you have that kind of dichotomy, the bond market tends to win out but this time, the reflationary theme has been more pervasive and bond yields are lower than would be expected given where we are with QE. As policy continues to normalise however, we would expect the scales to tip in favour of the deflation/recession camp and bond yields are likely to continue rising from here.

As stated, equity markets continue to shrug off political events here and overseas, marking new highs. But as they climb the so called wall of worry, it is hard to point to any sector that offers real value on a short to medium-term view. As markets move higher so does the risk and the importance of diversification should not be overlooked.

Looking further out, we continue to believe the relative value lies in developing regions such as Asia Pacific ex-Japan and Global Emerging Markets. These economies continue to grow at a faster clip than the US, but in part due to a stronger US dollar, their equity markets have lagged in recent years. With stronger fundamentals, there is room for catch up.

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Monday, July 10, 2017, 10:41 AM