Overview
After a sudden, severe, though brief bout of self-doubt, investor fear has evaporated again and equity markets rebounded, with the U.S.’ breaching new highs. The Brexit vote was the most visible trigger for June’s spike in uncertainty. But we live in an era of disbelief. The global political dialogue and myriad other events overwhelm the senses of many, even as U.S. growth continues to approach longevity records.
Meanwhile, monetary authorities continue to do yeoman’s work, stimulating growth and reducing unemployment. Universally criticized, central banks nevertheless carry on with innovative, if controversial, attempts to offset global excess capacity and deflationary pressures in the absence of any fiscal leadership. Some argue we should have elected officials running central banks. We couldn’t disagree more. But we may live to lost that battle.
North America
Tony M. Caxide, CFA®
Chairman - Senior Investment Council
The Trump-and-Clinton show goes on. It and a plethora of other catalysts for ambiguity are the framework for worker, investor and voter perceptions. And they’re all having an impact. The “man on the street” senses that the wheels are coming off and the country is going in the wrong direction. Facts, however, tell a different, rather more positive story, whether it’s workers’ sense of their own personal finances, crime statistics, sustainability of growth, levels of unemployment, or health and quality of life.
We’re still being buffeted by the echo of one of the most difficult recessions of the last 80 years, which itself came in the wake of the mid-2000s period of unhindered feelings of well-being, with credit granted to an unprecedented broad swath of the population. This made the subsequent pain all the greater and the self-doubt that much deeper. And now we’re just ending a bout with an historic drop in commodity prices. It’s little wonder that we feel boxed about the ears. But reality is better than perceptions suggest, as confirmed by the strong markets – so much so that we just lightened up on our very strong-performing high-yield bond position.
Japan
Jeffrey G. Wilkins,
Deputy Chief Investment Officer
Japan’s real gross domestic product grew at a meager 0.2% annualized rate in the second quarter, as consumption and investment both stagnated. No doubt in anticipation of those poor results, the central bank and government leadership announced further policy steps at the end of last month, including greater purchases of ETFs and modest fiscal stimulus. These steps are designed to accelerate inflation and growth. Japan has a cultural history of taking many small steps toward its goals over a longer period of time compared to its western counterparts. When many of its trading partners are trying to beat their economic doldrums by weakening their own currencies and exploring fiscal stimulus, larger steps may be required to jolt the Japanese economy from its languid progress.
Europe
Srinath Sampath, CFA®, PhD
Managing Director, Portfolio Management
The surprise June 23 vote by the United Kingdom to withdraw from the European Union caused worldwide market turmoil through early July, but without lasting consequences to continental European markets, which have largely recovered from the steep declines that immediately followed the referendum. One thing contributing to the market recovery was the fairly favorable verdict of the European Banking Authority (EBA) on the financial condition of EU banks (though the stress scenarios employed could have been tougher). At the July ECB meeting, President Mario Draghi emphasized the central bank’s continued support for the expanded Quantitative Easing program and hinted at the possibility of its extension beyond the slated end date of March 2017. In light of these and other positive developments, the EU economy posted a second-quarter GDP of 1.6% year-on-year, and is gradually on the mend.
UK
Jeff (Shengde) Liu, CFA®
Managing Director, Portfolio Management
Two months after the Brexit vote, the UK economy is showing signs of stress. Both manufacturing and service surveys weakened from expansion to contraction levels. Several other orders and sentiment indicators dropped. However, the magic hand of the central bank helped turn the equity market mood around with a rate cut of 25 bps and an increase in government bond purchases. Traders’ expectation of low rates and a weaker pound helped expectations for earnings and pushed the FTSE 100 Index up nearly 15% from the day of Brexit to mid August, even though second-quarter earnings were down 60% from a year ago. At current levels of valuation, the sustainability of the rally is hard to justify unless earnings more than double from the current level. This is hard to envision.
Emerging Markets
Jeff (Shengde) Liu, CFA®
Managing Director, Portfolio Management
Emerging markets (EM) earnings continue to be stagnant. However, a “goldilocks” monetary policy in most developed nations (though not the U.S.) and emerging countries induced risk takers, pushing EM equity and fixed-income markets and their currencies to their highest levels in a year. In China, stimulus measures started in late 2014 helped soften its economic slowdown, as banks lent a record 4.67 trillion yuan ($709 billion) in the first quarter. Negative rates in the EU and Japan keep pushing money to higher-yielding EM countries. These risk-on-trades may continue for some time. However, earnings need to improve for the equity market flame to keep burning.