deVere Group: Market Outlook
Andrew.J. Barros ACSI
Area Manager at deVere Spain SL | Wealth Management Consultant for the Expats and International Investors
Investment?Outlook
Tom Elliott
A fortnightly look at global financial?markets
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Market?sentiment:?Remaining unsettled. The ‘higher for longer’ U.S inflation and interest rate theme is unsettling global equity and bond?markets, and is driving the dollar higher. We may see more volatility regarding interest rate expectations later this week, if U.S Q1 growth (Thursday) and March PCE inflation data (Friday) come in above consensus estimates – which has been the case, with much economic data, in recent months.?
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Fed chair Jay Powell said last week that he wanted to see ‘sustainable’ progress towards the 2% inflation target, before he would support rate cuts. Given the recent direction of some inflation data (such as three consecutive months of rising headline CPI numbers), this could mean the first cut is closer to Christmas than is perhaps priced in by stock and bond?markets.?Markets are pricing in one or two 25bp cuts between now and the end of the year, sharply down from the six or seven cuts expected at the start of the year.?
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The return of the ‘higher for longer’ inflation and interest rates theme in the U.S has amplified the diverging interest rate?outlook?between the U.S and the rest of the world.?Markets currently expect the ECB to cut interest rate in June, and the Bank of England in August. The Bank of Japan, despite recently tightening monetary policy, has shown little appetite for further action.?
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Meanwhile, the first quarter corporate earnings season has begun. Global economic growth this year has been a little stronger than many had expected in early January, supporting corporate revenues, but ‘higher for longer’ U.S interest rates may lead to downgrades for more highly leveraged companies. All eyes are on the results and earnings statements of Magnificent Seven stocks in the U.S, which have come off the boil lately.?
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Markets are responding to interest rate differentials.?The U.S two-year Treasury yield, which is considered most sensitive to Fed interest rate changes, is up from 4.6% to 5% over the last month. The rise in comparable U.K gilt yields has been more modest, given the weaker growth and inflation pressures that exist in Britain. Rising government bond yields make other assets less attractive to own, everything else being equal, and sure enough the S&P 500 recently suffered a six-day falling streak, that ended yesterday, and the NASDAQ was down 5.2% last week. However, the U.K’s FTSE100 index achieved a new closing high yesterday of 8,023. It has been helped by the strong the dollar and by a move by global investors away from tech, and into value stocks,
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The strong dollar is causing a headache for U.S exporters, but delight for their overseas rivals in Europe and Asia. It is also a headache for those emerging?marketeconomies that carry large amounts of dollar-denominated debt, and for the Bank of Japan, as the yen touches 34-year lows against the greenback. The BoJ is in the unusual position of wanting to embed inflation, and raise long term inflation expectations, and is talking down any changes to policy over the coming months.?
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Geopolitical tensions in the Middle East have also contributed to the volatility in risk assets. However gold and oil prices -two traditional defensive assets during times of stress in the region- are down from recent highs.?
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Loose fiscal policy to blame??First quarter U.S GDP data, released on Thursday, is expected to show the economy growing at an annualised rate of 2.3% (source: Reuters consensus estimates), down from 3.4% in Q4. But the Atlanta Fed, amongst many organisations and economists, believe growth could be higher, given the strong March payroll numbers and very strong March retail sales figures. The Atlanta Fed is pencilling in an estimate of 2.9%.?
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The cause of this strong growth is increasingly being attributed to lax fiscal policy. Washington’s largess, whether on pandemic spending or green industrial projects, has helped extend the post-pandemic economic boom well beyond that experienced in other major economies. It is fuelling wage growth and inflation, as demand for labour exceeds its supply. Neither the Democrats or Republicans appear concerned about the budget deficit, and its impact on growth and inflation, and it is unlikely that November’s elections will alter this stance.?
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The revenge of the FTSE 100??The U.K’s main stock?market?index is up 3.9% since the start of the year, compared to a 2.1% gain on the Nasdaq. Is this the long-awaited revaluation of Nasdaq growth stocks versus FTSE 100 value stocks, that we have been waiting for? Yes, but it’s a muted revenge. Other value-driven stock?markets are benefiting more.?
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The Stoxx 50 index of leading eurozone companies is up 10.1%, while Japan’s Nikkei 225 is up 13%, over the same period. Even the S&P 500, that is dominated by tech, and tech-like stocks such as Amazon, is up 4.4%, as strong domestic demand is lifting all sectors. The gap between the FTSE 100 and the S&P 500 remains enormous: while the FTSE 100 is 16% above its December 1999 dot com high, the S&P 500 has more than trebled over the same period. The S&P 500 trades on a forward price earning multiple of around 22 times, the FTSE 100 halve that.?
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The FTSE 100 is benefiting from global investors’ preference this year for energy, commodity and financial stocks…but the U.K remains relatively unloved. This (probably) represents an opportunity for the patient long term investor, but U.K investors should be wary of increasing what may already be an overweight position in U.K stocks due to ‘home bias’.
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Outlook.?If Thursday’s first quarter growth exceeds consensus expectations, and if core PCE inflation shows an uptick on February’s 2.8%, on Friday, we can expect a further bout of?market?volatility. Longer term, disappointment over the delay in Fed interest rate cuts is likely to continue to cast a shadow over financial?markets.?
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Government bond?markets also face possible revolts by investors due to oversupply. Large budget deficits in the U.S, Italy and the U.K make any tax cuts, or promises of tax cuts, potentially explosive. U.K Chancellor Jeremy Hunt is hoping to deliver tax cuts in a pre-election autumn statement, he will be anxious to avoid another bond?market?sell off such as was seen in October 2022. Fortunately, the stronger than had been expected global economic growth this year -whether in the U.S, China and the U.K- lends some support to corporate earnings, and to stock?market?valuations, as do the relatively low valuations of U.K and many other European and Asian stocks. .
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Remain diversified!?As always, we suggest that investors look at financial history and take the hint: a multi-asset balanced portfolio offers the best long-term investment returns. Sure, stock?markets outperform bonds and cash on most 10 year plus comparisons, but the cost of investing in just one asset class is high volatility along the way. Not much good if one is saving towards a specific event, whether it be a child’s wedding or towards a pension. But if we add into the portfolio some bonds and alternatives, such as real estate and gold, we see that the volatility of the portfolio decreases at a faster rate than the decrease in returns. This is a free lunch for investors, achieved through diversification.