Fourth Quarter 2016
Report as at 31th December 2016
All regions of the world are set, for the first time since the financial crisis, to deliver economic growth. In the US, Trump’s expansionist policies have led to a slight upward revision to GDP estimates, to 2.2%, and for 2018 from 2.1% to 2.3%. European growth forecasts are around 1.4%, and Asia ex Japan is 5.7%. Globally, estimates are for growth of around 3.2%.
The fall in Sterling means that we anticipate inflation to rise quite sharply in the UK to near 3%, as goods and services cost more. Imported inflation is an exogenous factor which means that it will not necessarily lead to rises in the Bank of England Base Rate. Mark Carney and the other members of the Monetary Policy committee are likely to err on the side of caution when raising rates, given the uncertainties over Brexit.
The tight labour market in the US means that wages may start to rise, and this could feed through to higher inflation. Most analysts have three quarter-point rises forecast for 2017. Still, at perhaps 1.5% at the end of this year, rates are well below trend levels.
European economies are likely to benefit from continued quantitative easing programmes.
The markets have been strong in 2016, seeming to shrug off geopolitical events. However, in the UK much of this rise can be credited to a recovery in commodity prices and interest rate expectations. Highly valued ‘bond-like equities’ with stable earnings streams have been, and may continue to be vulnerable if interest rates do rise. However, many of these companies are still yielding well above interest rates, particularly in the UK. We keep a careful eye on valuations and remain particularly aware that equities can be a good hedge against inflationary pressures.
UK Inflation Linked bonds rallied strongly after the Brexit outcome, however, if inflation does stay below around 3%, look to be fairly valued. Conventional Gilts rallied sharply in 2016 but have since fallen back and remain expensive on most valuation metrics. Globally, there are pockets of value, and more differentials than before, with the US on a tightening tack and Europe still keeping liquidity conditions quite loose.
The supply side of the equation will also become more relevant in 2017. Up till now, quantitative easing programmes have led to massive bond buying programmes by Central Banks. However, the infrastructure projects announced by Trump, Hammond and others will lead to a greater supply, particularly of longer-dated government bonds. This will put downward pressure on prices (upward pressure on yields).
However, bonds will always provide some ballast in times of market uncertainty, as we have seen many times over the last few years – Brexit, the Eurozone debt crisis and the financial crisis of 2009. Therefore they still earn a place in portfolios for investors who do not wish to carry equity-only risk.
We look to generate stable returns for our clients by diversifying across different asset classes and buying well-managed companies and collective funds.
Please remember that the value of investments and the income from them may go down as well as up and that you may not get back the amount originally invested. Past performance should not be seen as an indication of future performance. Where an investment involves exposure to a foreign currency, changes in rates of exchange may cause the value of the investment, and the income from it, to go up or down.
09 Jul 2019In this issue of Outlook we examine the trade war between the USA and China, discuss the future role of the dollar, look at how an ageing population will change the way we work, and ask if it's still makes sense to own bonds.Read more »