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Larry Hatheway on Markets - April 2017

Chief economist and Head of GAM Investment Solutions, Larry Hatheway, discusses the outlook for markets, the significance of the forthcoming elections in Europe and how the outcomes could impact monetary policy.

Friday, April 28, 2017

Markets had suffered setbacks in recent weeks as enthusiasm about the reflation trade has dwindled. The catalyst behind this was concern that the Trump administration, facing political opposition around areas such as healthcare reform, would be stymied in its attempts to introduce growth supporting policies, including tax reform, fiscal expansion, and overall regulatory reform. Those fears are understandable given the complexities associated with initiating such policies in Washington at a time when there is so much disagreement.

What markets may have missed is that the world economy continues to perform on a solid foundation. China’s economic numbers from the first quarter were impressively strong, even if they are not sustainable over the medium term. Growth continues to improve across much of the advanced economy complex with few signs of weakening.

Markets are also responding to the fact that as good as growth is, it is no longer surprising to the upside. This suggests that one of the key catalysts for the performance of global equities, bonds and other parts of capital markets in the weeks and months ahead will be earnings. As we enter the earnings season, companies will need to demonstrate that the improvement in macro-economic conditions has translated to the bottom line. That is likely to be the case in the main, which is why it is too soon to be pessimistic about equities.

The other key driver will be political risk. Investors have greeted the outcome of the first round of the French elections with an increased appetite for risk, pushing up global equity prices and bond yields. Expectations are running high that European political risk will not derail global growth, allowing earnings to underpin further equity gains, particularly in Europe and emerging markets.

Both the second round of the French presidential elections and the UK general election will matter in their own right in terms of either being a source of political uncertainty or calming some of the uncertainties that are out there.

The elections will also matter for policy making, particularly from the European Central Bank (ECB). If France gets through the elections without major disruptions, it will be increasingly difficult for the ECB to defend its current stance, namely an accommodative policy with a bias to ease. The bias is likely to slip back into a more neutral stance which should support a further rise in bond yields, this time driven predominantly from Western Europe.

Overall therefore, the appropriate asset allocation stance in our view is to remain engaged in global equity markets with outperformance expected in Europe, emerging markets and Japan relative to the United States. We continue to look for secular themes within equities, including in information technology, and remain short of duration in fixed income markets with a preference for credit, particularly short duration credit vehicles.

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