There isn’t much for investors to be complaining about at present; unless you are a contrarian investor facing stretched valuations. Positive economic and market-driven data is widespread and continues across the majority of key markets. Economic growth and confidence gauges are strengthening, especially in the US, Europe and China, while corporate profitability continues to improve and unemployment edges lower.
This is a typical recipe for a cyclical market upswing, with participants pricing in the optimism while some commentators debate the durability of the economic expansion. The US continues to enjoy a stellar period of progress – both economically and in the markets – with consumer confidence now at a 14-year high and markets continuing to break new records.
Investors seem to be embracing everything that lies ahead of them at present, with the prospects of US tax reform and speculation over the Federal Reserve chairperson taken in its stride. The US dollar resurgence has also provided a modest tailwind for offshore investors, rising by approximately 1% against the euro and sterling.
European optimism has been another clear development, and October saw a further consolidation of this. The Catalonian independence vote posed a risk to Spanish and Eurozone stability, however the initial fear was followed by a sense of calm. Even the prospect of having a 31-year-old elected as the leader of Austria was embraced by investors. All of this leaves the European Central Bank with a challenging situation, as it pulls back on stimulus, cutting quantitative easing from €60 billion to €30 billion per month from January 2018, while grappling with stubbornly low inflation.
Global growth is also supported by China’s growth trajectory, which continues to run ahead of the government’s expectation; GDP growth of 6.8% year-on-year is ahead of the 6.5% expectation for 2017. This optimism was reinforced in the five-yearly China Party Congress, at which President Xi Jinping was re-elected for a second term.
Other key events in October were the Japanese election success of Prime Minister Shinzo Abe and hints that Brexit is moving forward in the UK. The former was embraced wholeheartedly by investors, whilst the outlook for the UK carries far greater uncertainty.
How Did Markets Move in October?
October was another strong month for investment markets, especially for equities. Both developed and emerging markets produced meaningful gains in the vicinity of 2% to 4% on average, with emerging markets slightly ahead once again. Asian markets were the standout, with Japan, Korea and Taiwan all rising by as much as 6% to 8% following the Japanese election and a lull in North Korean tensions.
Remarkably, technology companies around the world rose another 7% in local currency terms over October and are now up 39% year-to-date. By contrast, telecommunications stocks were the laggard once again, falling almost 2% and are now practically flat over 2017. This makes telecommunications the worst performing sector year-to-date alongside the energy sector, which was a beneficiary in October as oil prices rose 5%. The rise in crude oil prices was driven by expectations for extended supply cuts.
Bond markets were reasonably choppy during the month, remaining sensitive to central bank and geopolitical developments. European debt experienced heightened volatility following the Catalonia vote, although ended modestly positive over the month. Emerging market debt, especially local currency issuance, was a clear laggard, following a resurging US dollar as well as a deteriorating Mexican economy and the potential for a Venezuelan default. More broadly, corporate bonds slightly outperformed government bonds as credit spreads grind towards record lows.
Looking Forward – The Bigger Picture
As one reflects on the market developments, it is important to see the forest through the trees. We are clearly in the midst of a cyclical upswing, and while it is very difficult to know how long it will last, we do know that valuations are stretching beyond reasonable estimates.
To validate such a thesis, we do not need to look far. The global share market has rallied by 20% year-to-date and emerging markets are up by 33% – a clear sign of optimism among market participants.
While we naturally welcome positive returns for our investors, we must similarly acknowledge the challenges it presents. The valuation-implied return expectations we calculate for markets continue to deteriorate, meaning prudence should be adopted. While pockets of opportunity continue to present themselves, we generally advocate that investors protect themselves against an increasing probability of a market setback. We do this at a portfolio level by maintaining healthy diversification and holding some ammunition readily available for any opportunities that present themselves.
