30 April to 7 May: Benefit of the Doubt

On Friday, the US jobs report confirmed unemployment had fallen to 3.9%, a low last reached in December 2000 and before that in January 1970. As a consequence, the probability of a FED interest rate hike in June rose to near enough 100%. Indeed, the market is now pricing an over 40% chance of 4 or more hikes over the full year. However, a more detailed inspection of the labour market numbers reveals the decision to hike rates is not necessarily as obvious as it seems. In April, labour market participation fell back to 62.8%, the middle of the recent range but almost 5 percentage points lower than in 2000. Moreover, average hourly earnings came in below expectations at 2.6%. In short, whilst the FED appear happy to give it “the benefit of the doubt” and assume historical calibrations of the Philips curve (an inverse relationship between unemployment and inflation) will hold, for now the labour market isn’t working like it did in the past. This is to say, low unemployment is not attracting more people into work or forcing higher wages. And this is not just a US phenomenon – in Japan unemployment is at 2.5% and in Germany at 3.4%, but similarly there is no meaningful wage growth in real terms.

Whether it is because of ageing demographics, deflationary and job saving technology or overleverage, the window into the economy provided by employment certainly suggests this time is different for many developed economies.

23 to 29 April: Pique or Peak

After 18 months of perfect calm, global equity markets have traded lower and with increased volatility since late January. Indeed, even over the past few weeks during which corporate earnings for Q1 have come in well-ahead of expectations, stocks have struggled. Is this a fit of pique or have markets peaked for this cycle?

Excluding a number of emerging countries, we believe economic conditions for this cycle have seen their best days; corporate margins, policy stimulus and growth have already touched their highs. Recent price action is therefore rational as investors have readjusted their forecasts as incoming data has suggested the good times cannot last forever. However, we believe global indices will trade to new highs. It might be long in the tooth, but the party is not over yet.

This week there is an FOMC meeting and the April employment report in the US. Japanese markets will be mostly closed for Golden week.

16 to 22 April: No Free Lunch

Last week, the IMF released its updated “World Economic Outlook”. Just as in January, the fund believes global growth will continue at a cyclical peak of 3.9% until 2020 (an acceleration from 3.8% last year). However, the forecast came with a caution that “momentum is not assured”, particularly in light of “waning support for global integration”, and “despite the good near-term news, longer-term prospects are more sobering.” Whilst we think the growth projections are too optimistic, we would agree with the overall sentiment. The cycle is not yet over but the structural issues facing developed countries are starting to rear their heads again, whilst those countries that overly rely on natural resources also face a pressing need to diversify.

With respect to the commodity space, the WTI oil price came close to USD 70 per barrel (69.56) before falling back later in the week. This prompted President Trump to tweet, “Looks like OPEC is at it again. With record amounts of Oil all over the place, including the fully loaded ships at sea, Oil prices are artificially Very High! No good and will not be accepted!” Following sanctions on Russia, metal prices have also surged over the last 2 weeks, aluminium because Rusal has been banned from selling in a number of countries and palladium and nickel because of worries Norilsk Nickel could be targeted next.

9 to 15 April: New Normal

After a vicious rally and equally potent sell-off at the start of this year, equity markets have oscillated uneasily with no clear direction. Our view remains that we are in a new regime. The economic cycle has matured, with the US late cycle, and although some emerging countries remain in a “sweet spot”, the general picture is now of higher volatility and a more classical inverse relationship between bonds and equites. Of course, every period of history has its own peculiarities. Today, the unorthodox and tweet-based interventions of the US president represent such a variable, with the ability to shape market direction over a daily time window. In this sense, last week was a good representation of the paradigm we think markets are in; equities rising over the week, bonds modestly lower and the overall direction punctuated by political soundbites. Actually, there was a more sinister tone to the news flow with tensions building between the US and Europe on one side and Russia on the other over an alleged chemical weapons attack by the Assad government in Syria. This led to an allied response of more than 100 missiles on government facilities in the early hours of Saturday morning. Whilst Russia condemned the attacks, it stopped short of using its air defences or threatening retaliation.

Elsewhere, oil prices posted a strong rally (best weekly performance in 8 months) rising to their highest level since 2014. Latest gains came amid the rising geopolitical tensions in the middle east and an IEA report that estimated global inventories have fallen back to their 5-year average. However, they were in spite of US crude production touching a record high, with output now greater than that of Saudi Arabia, and the US rig count still rising.

3 to 8 April: Almost according to plan

Since the global financial crisis, US markets and the economy have outperformed peers as a more aggressive and timely policy response helped address the banking system and mitigate (temporarily) a structural growth problem. It has been our view for the past few months that we would now see an end to this strong relative performance. Put simply, the US is later cycle and more expensive than most other regions. In this sense, the year has gone according to plan. Volatility has increased and US equities and bonds have weakened, whilst markets such as Brazil and Egypt, in the early stages of an expansion, have prospered. Moreover, we have seen the first signs of uncertainty in the technology sector, the most overweighted and highest multiple/growth-oriented area of the market.

However, not everything has gone according to script. Last week, Donald Trump escalated his trade attack on China. There is clearly still room for negotiation, but also now a concrete risk of a full-blown trade war between the two biggest economies on earth. This is of course important, both tactically and (potentially) fundamentally, but it does not change our “top picks”, Latin America ex-Mexico, Egypt, South Africa and India; domestically focused economies that are still in Goldilocks territory, enjoying the lagged benefits of monetary easing and reform.

26 March to 2 April: Walking on (Easter) Eggshells

Last week, the trend of more volatile asset prices continued. At first glance, it might appear “bad luck”; that markets are being buffeted by an unusual number of idiosyncratic news items. However, we think this is instead symptomatic of a change in regime as, mostly in the US, later cycle dynamics, which include tightening monetary policy and labour markets, bring an end to 18 months of “Goldilocks” economic data. This more uncertain macro picture, coupled with rich valuations, leaves investors more sensitive to negative headlines.

Notwithstanding the importance of the US to the global economy, we reiterate our more constructive outlook on a number of emerging markets (Latin America, Egypt, South Africa, India), where macro tailwinds remain.

This week we have the March employment report in the US. Consensus expects average hourly earnings to come in at 2.8%. A print above 3% would in our view drive Treasury yields higher.

19 to 25 March: Playing the Trump card

On the face of it, last week’s equity market sell-off, the worst in 2 years for the US, was all about the threat of Donald Trump starting a trade war. The reality is a little more nuanced:

• Anti-Trade or Anti-China? Whilst the POTUS did announce a 25% tariff on up to USD 60bn on Chinese imports with high intellectual property content, the Trump administration exempted numerous countries, including the entire EU and Korea, from the steel and aluminium tariff. Moreover, progress was made on NAFTA as the US abandoned its requirement that 50% of the content of vehicles assembled in the region must come from the US.
• Bark or Bite? Trump’s modus operandi is to make aggressive public statements, which are then watered down during implementation. The Chinese also appear keen to maintain a constructive dialogue.
• Tip of the Iceberg? It is not just trade via which Trump’s unconventional management style threatens to create volatility. Turnover in his administration continued last week with National Security Advisor H. R. McMaster replaced by former U.N. Ambassador John Bolton and John Dowd, Trump’s chief attorney in the Mueller probe, resigning. According to the Brookings Institute, this means around half of the President’s key staff has left since he was inaugurated. Indeed, the Washington Post highlights that there will have been 3 national security advisers, 4 communications directors, 2 chiefs of staff (and the incumbent is currently out of favour), 2 press secretaries and 2 FBI directors in 14 months.
• Data Lull? It’s not all about Donald either; after the strongest and most broad-based period of growth since the GFC, the market got carried away in January and has struggled for direction as economic data has moderated.

Whilst we certainly do not wish to ignore the danger of US led geopolitical upheaval, our core outlook remains unchanged. We are in a new more volatile regime, given marginal headwinds are building, but we expect global growth to continue. Greater uncertainty is particularly the case in the US, which we see as later cycle than its global peers.

Bucking the risk-off trend last week, were oil markets. Crude prices hit seven-week highs, following the biggest weekly gain in 8 months, after increased tension in the Middle East and speculation OPEC could extend output limits.

12 to 18 March: Looking for answers

After January’s euphoric top, investors appear to have lost conviction. Initially, this change of sentiment was prompted by the interconnected threesome of higher oil prices, US wage growth and bond yields, which collectively threatened to end the previous 18 months of “Goldilocks” conditions via the potential for tighter monetary policy. More recently, Trump’s anti-trade agenda, Russia’s alleged poisoning of a former spy in the UK and Italy’s messy election result have added a political flavour to this uncertainty. Moreover, a number of weaker data prints (particularly in Europe) have confused the growth picture.

All this notwithstanding, we continue to hold a positive view on equities and growth (particularly outside the US). Whilst the FED is all by certain to raise rates again this week, other central banks are unlikely to follow. Indeed, in emerging countries such as Brazil, Russia and South Africa we may see easier policy. In addition, the moderation in developed market economic data is normal after the unsustainable surge in Q4 2017, but releases are still consistent with some of the best growth since the financial crisis. Therefore, we expect positive momentum to return, but amid higher volatility; conditions are still constructive but no longer perfect. As it relates to the US, this month’s average hourly earnings release offered a temporary reprieve from higher bond yields. However, we believe price pressures are slowly building and there is an inevitability of higher yields, with 3% yield on the 10-year a potential flashpoint for markets.

5 to 11 March: Weighing it Up

Last week, there were a number of important data releases and events for markets:

• In the US, average hourly earnings did not accelerate, and Trump’s tariff proposals were watered down.
• In Europe, the SPD voted to end Germany’s political deadlock and the ECB stayed dovish despite removing their easing bias by reducing their inflation forecast.
• In Japan, the Governor of the BOJ appeared to talk down the potential for policy normalisation
• Gary Cohn, Trump’s chief economic advisor, resigned in protest at Trump’s protectionist change of course.
• In Italy, the election result left no clear path for government and risks populist and unhelpful policy going forward.

We continue to believe we are in a new, higher volatility regime, and we also now see a tail risk of a Trump inspired trade war. Nonetheless, we think last week’s news flow, in aggregate, should be taken positively; there is not enough evidence that US inflation is accelerating (albeit we have another reference point on Tuesday with the release of February CPI) and, across the rest of the world, policymakers appear in no hurry to tighten the monetary purse strings.

26 February to 4 March: Unchartered Waters

Over the weekend and in the coming week, a number of events could impact the short-term direction of travel for markets:

• Sunday, the SPD in Germany ratified a coalition deal that secured Angela Merkel’s 4^th term as chancellor and Italy held a general election, with exit polls suggesting a hung parliament.
• Thursday, the ECB may change their forward guidance after their March monetary policy meeting
• Friday, the US employment report for February will confirm whether wage growth in the US has experienced a genuine acceleration and the BOJ in Japan will announce a policy update

Whatever the near term volatility, we continue to see global growth as sufficiently resilient to deal with this period of adjustment for at least the next 6-9 months.