Instreet Market & Economic Commentary & Opinion
Offshore equity markets have recovered quickly since last Wednesday’s sell-off which was prompted by growing fears that US President Trump would be impeached. Markets aren’t concerned with the impeachment itself, but rather what would happen to the re-inflation policy if Trump wasn’t President anymore.
Over the weekend, more news stories have come out on Trump’s actions with the firing of the FBI director. The speed of the stories means that we are likely to hear more over the coming weeks.
The equity market seems to have priced in the political risk associated with Trump and we think the current equity rally is more to do with the pick-up in global growth, rather than the Trump re-inflation trade. As such, with global fund managers holding large levels of cash, the mantra of "buy on the dips" still holds.
The equity market rally, however, largely remains unloved despite strong earnings in the US, Europe and Japan. It seems that market participants are waiting for a catalyst to push the markets higher or lower. I don’t think they’ll get one. Rather, I’m expecting a slow, quiet move to the upside which many investors may not notice until the end of the year.
Credit and currency
Treasury bond yields have dropped to levels that are lower than when Trump was elected. This means the credit market may be pricing in more political risk than the equity market.
As for the Dollar, the US Dollar index is at lower levels than when Trump was elected. One possible explanation is that investors do not expect stronger growth in the US and globally to translate into higher inflation and interest rates.
Another explanation is that fading political risk in Europe has strengthened the EURO against the US Dollar. We are also seeing a revival in the euro-zone and Japanese economies – both of which are now growing faster than the US. This is leading to speculation that the European Central Bank and Bank of Japan might reduce the pace of their asset purchases sooner than previously thought.
Finally, long USD has been an overcrowded trade and the recent incidents with Trump may have been a catalyst to sell.
Emerging market equities have climbed by 20 per cent in the past six months, reaching their highest level in nearly two years. A key driver of the rally has been increased optimism about the prospects for corporate earnings, fuelled by a recent pick-up in GDP growth and the run-up in commodity prices late last year.
The pick-up in global growth should continue to support emerging market equities, albeit not at the same pace of growth we have seen over the last six months.
Fund managers don’t seem to think that emerging markets are running too hard. Indeed, the Bank of America Merrill Lynch's Global Fund Manager Survey released earlier this week showed that only 5 per cent of participants cited emerging market equities as the "most crowded trade". Rather, the biggest worry currently are US tech stocks.
Elsewhere in the world
Two other updates of note:
- Japan: According to last Thursday's preliminary estimate, Japanese GDP rose by 0.5% in Q1. Even with this strong growth, we think the Bank of Japan is unlikely to tighten policy until there are firm signs of inflation and wage growth.
- Australia: Australian labour market data was released last Thursday, showing an uptick in employment of 37,400 for April. Combined with unemployment dropping back from 5.9% to 5.7%, the RBA now may be less fearful of rising unemployment in Australia.
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