“Elections, elections, elections”. There is no doubt that investor sentiment has been dominated by elections in the first half of 2017, with the perceived relief in France in April, offset by the negative impact of the U.K. election in early June.
The growth sectors continue to excel, with technology rallying strongly
Despite the distractions, markets have been exceptionally resilient and continue to move forward.
Supporting this has been a delicate economic expansion – wage growth is generally disappointing in the developed world while unemployment remains near cyclical lows – and positive sentiment indicators continue to propel markets higher. Sensing an opportunity to ‘normalise’ its policy stance, the Federal Reserve has stuck to its plans to raise rates thus far, with moves in December, March and now June. These have been mostly anticipated by the market and have therefore been reasonably well absorbed.
Of greater note, the euro and sterling currencies have been buoyed by the perceived stability in the European Union and the whispers of central bank tightening. The euro has been the standout against the US dollar and the yen in recent times, while sterling has also rallied off a low base.
This currency impact should not be underestimated as it has distorted the return profile of markets significantly. In a post-Brexit environment, this undoubtedly acted as a tailwind to the benefit of UK domiciled investors. However, any sterling appreciation from here cannot be disregarded and requires a very watchful eye as it has the potential to drag on offshore returns.
Focus on the Market Developments
Interestingly, fixed income returns have been curiously correlated to equity performance throughout this cycle. This is especially true in the European region, where both equity and fixed income markets have been moving mostly in sync.
While sentiment has certainly started to swing back towards European equity markets, fund flows continue to show a general preference for fixed income among global investors. This behavioural element must be considered holistically but may also say something about the uncertainty many investors are grappling with in the current environment.
Underpinning this, central bank speculation remains rife and recent speeches from central bank governors Mark Carney in the UK and Mario Draghi in Europe raised concerns that loose monetary policy from central banks may be coming to an end. This is causing fixed income yields to react, albeit from a very low base.
Equities Pushing Record-Highs
Putting these issues aside, one must be reminded that it has been a resolute and positive period for investors, even when we exclude currency shifts. Among the broad equity markets, both developed and emerging markets continue to post upbeat returns, with emerging markets now beating developed markets for six consecutive months to the end of June.
Underlying this surge to new record-highs, the so-called growth sectors also continue to excel, with technology rallying particularly strongly.
Among other influences, we continue to witness the rather rapid deterioration of commodity prices. Oil has fallen significantly, which has been putting pressure on commodity-related assets. However, emerging markets – as well as the energy and materials sectors more broadly – have been reasonably resistant given this weakness, brushing off the longstanding correlation to commodity prices and extending higher in local currency terms.
What Does this Mean for Investor Portfolios?
By putting this in context, it is clear that we continue to live in a world of healthy optimism, strong returns and a fragile footing. The danger to this, of course, is that it increases the chances of future weakness as prices accelerate beyond the fundamentals. From a portfolio construction standpoint, this implies a requirement for level heads and a disciplined approach as one navigates the course to deliver on their long-term goal.
While pockets of opportunity appear to be identifiable via a contrarian mindset, patience and the ability to focus on fundamental developments are key traits we are identifying with.
Bringing this together, we continue to caution investors against their own behavioural biases and advocate that they ignore placing too much emphasis on any short-term sentiment. While some of the “big events” of 2017 are now behind us, the reality is that much of the positivity is now priced in and the implications of events such as Brexit are still largely unknown. This is a risk in itself and will impact investor behaviour for some time to come.
To bring this to life, one should consider the sizeable positive shifts in both equities and bonds. A valuation-driven philosophy therefore leads us to favour more cautious positioning as valuations for equities and bonds remain stretched.
