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Larry Hatheway on Markets - July 2017


27 July 2017

Chief economist and Head of GAM Investment Solutions, Larry Hatheway, discusses the outlook for global equity and bond markets, his expectations for the remainder of the second quarter earnings season and monetary policy over the next quarter.

In the second half of 2017, the outlook for markets will be more challenging than in the first half. In the first six months of the year global equities performed well, supported by stable growth, rising earnings and low inflation. Bond yields rose in the first quarter, before settling into lower ranges in the second quarter.

Looking ahead, the supporting factors for equities remain intact, but valuations are higher and the market is showing signs of exhaustion. The recent advent of dollar weakness and euro strength has sapped performance from European markets as investors have correspondingly lowered European earnings forecasts. The degree of European recent underperformance also reflects overweight positions, which are in the process of being trimmed.

Bond markets are likely to produce weak returns as the Fed continues to normalise policy and as the ECB lays out its 2018 strategy of tapering asset purchases.

Overall, therefore, the outlook suggests more subdued returns, but without major setbacks, for capital markets in the second half of 2017.

The second quarter earnings season has supported global equities, with mostly positive returns across sectors, including financial and technology firms. Still, expectations are high and therefore difficult to beat. Looking ahead, the earnings focus shifts to Europe, where over one hundred companies report this week, and to Japan and emerging markets. For the most part, the result should be positive, given a cyclical upswing in Europe and much of the emerging complex, as well as signs of sustainably higher earnings in Japan.

As noted, the coming quarter will see further signs of monetary policy normalisation. The Fed will continue on that path despite moderate growth and still low inflation. The Fed is likely to postpone further interest rate hikes until December, if not next year. Instead, the Fed will focus on balance sheet reduction. An announcement is expected in September by which maturing assets will be allowed to roll off the balance sheet. The ECB is also likely to announce the path of balance sheet adjustment—or tapering of asset purchases—to commence in early 2018. Several other central banks may also adjust their policy outlook, among them the central banks of Canada and Sweden.

In our portfolios, we are taking a slightly more cautious stance, reducing some of our exposure to global equity markets in favour of carry positions, particularly in areas of subordinated debt and off-the-run debt securities, including mortgage-backed securities. We are also looking at parts of the emerging complex for carry positions. The reduction in exposure to equities is not necessarily a negative view on global equity markets; it simply reflects a loss of momentum.


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