CIO July Outlook: “Noise around trade and politics is increasing market volatility”

Tilney Chief Investment Officer Chris Godding examines the themes likely to dominate investment strategy

After a challenging first half of 2018, with global investors having to digest constantly evolving geopolitical headlines, diverging Central bank rhetoric and solid earnings growth data, one wonders what is in store for the remainder of the year. Chris Godding, chief investment officer of wealth management group Tilney, which oversees £24 billion of assets, cites political power plays having the most impact on the current economic headlines.

Godding commented: “The beginning of 2018 has been a mixed bag in terms of growth. We have seen Europe struggle to maintain the momentum of late 2017 while the trend in the US continues to be very positive. China has been steady but tighter credit conditions put in place last year are beginning to dampen consumer demand. The US Federal Reserve has taken a more hawkish position continuing to operate at near full utilisation and remains on track to increase interest rates twice more in 2018 and another two to three times in 2019. The UK economic situation has also improved through the year, with valuations becoming more attractive in what is still a relatively unloved market. As a result, we favour further US exposure and have added back to UK equities.

“UK equities enjoyed a strong second quarter and with the latest inflation and unemployment data remaining steady, as with the Bank of England’s (BoE) Monetary Policy Committee, which voted to keep rates on hold for the time being, hopefully the sector will continue positively for the second half of the year. Like the rest of the world, the BoE will be watching Brexit developments closely over the summer as the deadline for a trade agreement with the EU draws ever closer.

“We expect the People’s Bank of China will ease policy in response to the weaker data and that further appreciation of the renminbi against benchmark currencies will halt. This will help to slow the deceleration of credit expansion, with the caveat that Beijing is committed to an improvement in credit quality and that any stimulus is likely to be incremental rather than material. In addition, the escalation of the provocative tit-for-tat trade strategy between China and the US is unsettling for investors. Although we believe a sensible compromise will prevail on trade, the potential for a negative surprise is an additional risk that investors now have to factor in.

“The backstop of the Fed “put” may have been removed but the positive perspective for investors is that monetary policy remains unduly stimulative. Quantitative tightening by the Fed is effectively being offset by loan growth and the level of excess reserves in the banking system suggests that this has further to run. Unemployment is below the Fed’s target and consumer confidence is strong, with real wages rising around 1% and supporting higher retail sales. In the new isolationist world, the US economy is in good shape and the gradual approach by the Fed is not an immediate negative for risk.

“The direct US-North Korea diplomacy has effectively reduced China’s ability to leverage its influence over the rogue state in trade negotiations and improved the probability of an optimal result for the US. It is also a victory in the hegemony scoreboard for Trump at a time when America’s primacy is being challenged by Beijing. China is likely to ease monetary policy to offset any negative economic impact of trade concessions, possibly via a modest depreciation of the renminbi and a reduction in the reserve ratio requirement for banks. China is constantly concerned that a weak currency will lead to capital flight but, on a labour cost-adjusted basis, the renminbi is overvalued and the contribution of real export growth to GDP has been negative for the past 18 months.

“The ECB also took the unusual step of softening the QE message with a promise not to raise rates before the summer of 2019. This is new in the lexicon of central bank messaging and was quite a surprise to investors. It is the first time a major central bank has committed to a calendar timetable and it leaves the ECB vulnerable to the embarrassment of reversing policy if their conservative inflation target is exceeded. A dovish handcuff is a positive for risk assets and should help stimulate European growth even further. Inflation will pick up via euro depreciation and the troublesome Italian economy will benefit from a weaker currency. For the ECB, a weaker currency is preferable to political upheaval.

“In summary, the noise around trade and politics is increasing market volatility but overall the net effect could be to extend the cycle by limiting the tightening of monetary policy. The US will benefit most from the trade tactics, and concerns regarding Italy should fade. The internal imbalances in Europe should moderate and China will ease financial conditions, either via monetary policy or the currency versus the US dollar. The positive growth picture in emerging markets is already under threat from US dollar repatriation but we think the bulk of the easily accessed reserves have moved. If the repatriation damage does not abate, then China would need to react more aggressively with monetary policy or step in to provide liquidity fairly soon. Overall, the conclusion is that trade tariffs add uncertainty to markets but the net effect should ultimately be a positive for equities – through easier financial conditions that extend the cycle.”

If you would like to speak with Chris Godding and get any further updates on his market outlook, please get in touch with Gillian Kyle – Gillian.kyle@tilney.co.uk

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Important Information

The value of investments, and the income derived from them, can go down as well as up and you can get back less than you originally invested. This article does not constitute personal advice. If you are in doubt as to the suitability of an investment please contact one of our advisers. Current or past yield figures provided should not be considered a reliable indicator of future performance. The opinions expressed in this article are made in good faith, but are subject to change without notice.