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Larry Hatheway on Markets - November 2017

Chief economist and Head of GAM Investment Solutions, Larry Hatheway, discusses the current global macro environment, the biggest risks to investors in the remainder of 2017 and the impact of political uncertainty on markets.

Thursday, November 09, 2017

The outlook for global equity markets for the remainder of 2017 remains positive. Equities are supported by robust and synchronised world growth, as well as by positive third quarter earnings. Around 70% of S&P 500 companies have beaten consensus expectations and we would expect earnings reports in Europe and the emerging markets to do better, representing a cyclical improvement in profitability in those regions.

For bond markets, on the other hand, the operative word is more defensive. Central banks are beginning to adjust monetary policies, as we saw most recently from the Bank of England, which now joins the Federal Reserve and the ECB in a normalisation process. Bond yields are drifting sideways but are likely, in our view, to continue to move higher before long, suggesting poor returns in global duration fixed income.

The biggest risk to investors over the remainder of 2017 is an upside melt-up in equity markets. Some regard equity markets and valuations, having made very strong advances in 2017, as stretched. However, momentum is a clear driver in the short run for all markets, including for equities, and there is a sense that we may see a further surge in equities in the final quarter, which many investors may not be prepared for.

The key downside risk is the emergence of higher inflation. While we do not see many signs of accelerating inflation at the moment, markets are complacent about that risk, particularly as we approach full employment in the US, the UK, much of Europe and Japan.

Investors also seem unresponsive to political uncertainty, despite many sources of worry including the potential for geopolitical conflict, the possibility that tax reform could fail in the US and the advent of separatist movements in Europe. Volatility, instead, remains low and risk assets continue to perform well. We believe it will take a bigger shock to unnerve markets, largely because the underlying fundamentals of synchronous non-inflationary growth and high returns on capital remain intact.

Accordingly, we remain overweight where the fundamentals are most supportive, with a preference in global equities for emerging markets, Japan and Europe. We believe it is also prudent to marry equity ‘beta’ exposure with uncorrelated sources of returns, including relative value trades, merger arbitrage positions and other mean reversion positions, which add stability to portfolios. In doing so, we seek to deliver returns in a way that minimises downside risk without being reliant on government bonds.

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