Monthly Market Outlook January 2018/February 2018Monthly Market Outlook Article
It has been a turbulent few weeks in global markets, which saw a strong start to the year and then a sharp fall from the January highs. While rising interest rate expectations in the US may have triggered the falls, technical factors kicked in which made things much more dramatic. We should keep in mind that, whatever the explanation is, the global economy is broadly in a healthy state with low unemployment and companies' earnings continuing to grow. Thus, beyond the noise and day-to-day market moves, there is underlying long-term support for equity investment.
The economic picture in the US particularly is robust. Soft economic survey data is at multi-year highs, the recent earnings season has been strong and Trump's tax reforms are likely to bring a further boost in the coming year. Jerome Powell has been sworn in as Federal Reserve (Fed) Chair and has stated he will continue on the path drawn by his predecessor, whilst paying attention to market developments. In this environment, the equity market moves in recent weeks may have come as a surprise to some.
With easy money, the potential for a rise in inflation has been a concern for some time but the deflationary influence of technology, globalisation and an ageing population has helped to keep it low. In January, US bond yields started to rise and the market priced in about three further rate rises in 2018. The Trump boost to an economy, that was already doing well, raised fears of overheating with rates having to go up faster and further than expected as a consequence. This caused US equity markets to start to sell off and the move was exacerbated by volatility and systematic trading. With interest rates rising, some commentators speculated that the Fed would be unlikely to step in and loosen monetary policy if markets take a hit. We believe however that a further dramatic fall could encourage the Fed to delay their scheduled rate rises, although we think that this is an unlikely scenario.
Where the US leads, others follow but the FTSE 100 was in less good shape already. The Bank of England (BoE) had raised rates in November and Gilt yields were moving higher. Talk of a softer Brexit and these higher yields pushed the pound higher, particularly against the US dollar. Since the UK market is an index where a majority of revenues come from overseas, the rise in the FTSE was much smaller and the fall more painful than the US market. The BoE Monetary Policy Committee provided little relief with, if anything, a more hawkish stance predicting rates would rise sooner and faster than they expected in November. If economic growth goes on as expected, we should see another rate rise in May. While the FTSE 100 Index is very international, the bond market is more susceptible to economic changes and these are mired in the fog of Brexit negotiations.
European markets were not spared from the market sell-off despite economic data indicative of robust growth and a good results season. The European Central Bank (ECB) made no change to policy at its latest meeting and stressed that it will be patient in normalising, conscious of a strong currency and weak core inflation. Thus, any hikes are likely a long way off. Political concerns in Germany have faded as it now seems likely that Merkel will be able to form a coalition government, yet the Italian election still poses a risk as the populist Five Star Movement are leading in opinion polls.
At the time of writing, markets have given up some of the strong gains from the previous year and the move is unlikely to have much economic impact. However, if it was to fall further then there is a danger that moves on Wall Street spill over into the wider economy. If this were to occur we could see the Fed moving any future rate rises further out. For now, the central bankers here and in the US appear to see this as a healthy correction.