Update April 2017 Economic optimism

Valuations have changed very little over the past month. Equities continue to be more attractively valued than government bonds. European equities are still more attractively valued than their US counterparts. Moreover, earnings forecasts are rising in Europe, while these are declining in the US.

“Reflation trade” grounds to a temporary halt

The rally on the US equity markets and in bond yields in the wake of Trump’s election was chiefly driven by promises and confidence. This “reflation trade” ground to a temporary halt in March, in part as a result of the political setbacks Trump faced. There are growing doubts among investors as to Trump’s ability to deliver on promises. We still count on an economic boost from tax cuts and large-scale infrastructural projects, but it will take a while to be felt. The lower oil prices also contributed to the interruption to the rally. A temporary fall in oil prices was triggered by rhetoric demonstrating that OPEC does not wish to subsidise shale oil producers and by high oil inventories in the US. We believe that the supply/demand ratio will improve in the second half of this year, which will support oil prices. The dovish language coming from the US central bank also played a role. Although policy interest rates were raised, market fears of a faster pace of interest rate hikes proved to be unfounded. The risk of the economic cycle quickly coming to a close has declined further.

Global growth momentum is picking up

In spite of the economic policy uncertainty, the global economy has got off to a strong start in 2017. Leading indicators point to a persisting recovery in global growth. Although the economic policy boost in the US is likely to take a while to filter through, the US is maintaining its current pace of growth. In the Eurozone, manufacturers and consumers are taking little notice of the political uncertainty. We have consequently adjusted our growth forecast upwards and anticipate acceleration in growth. This makes us more positive about European equities. Last month, the UK officially triggered the Brexit process. The uncertainty this will create will probably lead to a slowdown in growth in the UK. In Japan, growth is picking up slightly, but the path to a full recovery is long. In Asia (ex. Japan), export-oriented economies are succeeding in profiting from the improved global trade momentum. When combined with the fact that China is slowing at a slower rate than expected, we foresee stable growth for the region as a whole. Emerging markets are slowly climbing out of the economic low. They are also profiting from the upturn in global growth and higher commodity prices. Yet the upward potential is restricted by tighter financial conditions and little room for budgetary stimulation.

“Although inflation has risen sharply in developed countries over the past few months, this has chiefly been driven by base effects (including higher oil prices). ”

Central banks to pursue less expansionary monetary policies

Although inflation has risen sharply in developed countries over the past few months, this has chiefly been driven by base effects (including higher oil prices). Over the next few months, general price levels will probably fall again slightly. The underlying pressure on prices will also remain low. However, the removal of fears about deflation will allow central banks to gradually scale back their highly-expansionary monetary policies. The US central bank will raise policy interest rates further, while after the summer the ECB is likely to announce a further tapering of its bond-buying programmes as of January 2018. This will further push up yields on government bonds and credits. We also expect the Japanese central bank to raise its yield target of about 0% for Japanese 10-year government bonds in 2018. The upward pressure on Japanese 10-year bond yields is forcing the BoJ to buy up government bonds, but it cannot keep doing so indefinitely. For the time being, however, we believe that the Japanese central bank is happy to maintain the spread between the US and Japan government bonds. This has a downward effect on the yen, providing an additional boost for the economy. Of all the major central banks, the UK’s is likely to be the only one that leaves its monetary policy unchanged.

Political risk continues to affect sentiment 

A wave of relief washed over the financial markets in the wake of the VVD’s victory in the Dutch general elections. Investors have now turned their attention to France. As we have said before, we expect this year’s Eurozone elections to fizzle out without a bang. We do not anticipate Marine Le Pen becoming the next French president. If this does happen, however, we believe that there is only a small risk of a Frexit. We believe political risk to be highest in Italy. Political events will continue to affect sentiment on the financial markets over the next few months. Sentiment on the financial markets is positive due to the improved outlook for growth, but we have not yet reached the euphoric stage.

Disclaimer
Kempen Capital Management N.V. (KCM) is licensed as a manager of various investment funds and to provide investment services and is subject to supervision by the Netherlands Authority for the Financial Markets. This information may not be construed as an offer and provides insufficient basis for an investment decision.

The Asset Allocation  Desk

Marius Bakker
Ivo Kuiper
Joost van Leenders

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