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Putting the first quarter into perspective

05 April 2018

Jonathan Marriott – Chief Investment Officer

At the start of 2018, we welcomed an extension of the positive equity market performance seen in December. This was supported by strong economic data and growing company earnings. In the US, rates were expected to continue rising however over the last year rate rises were managed with little impact on the equity market. President Trump's tax reforms looked as if they would give a further boost to the economy. In short, all looked well in the world. 

As we approached the end of January, markets began to selloff. The selloff was made worse by technical factors around volatility and by computer generated sales. After this initial selloff, markets recovered only to sell off again. In a sense, the initial selloff came from an excess of good news in the US. It was feared that tight labour markets would give rise to higher wages and inflation. The tax cuts and potential increased spending would add stimulus to an already strong economy.  As a result, the US Federal Reserve would be raising interest rates faster than had been expected.  With the Bank of England ("BoE") and the European Central Bank also looking to withdraw the stimulus measures they had been applying, it looked as though we were about to see tighter monetary conditions than had been expected.  The company earnings season generally exceeded expectations helping the markets recover some of the losses, led largely by the US tech stocks.  However, Trump's announcement of trade tariffs on steel and aluminium started fears of a trade war and subsequent exemptions for many countries did little to improve the situation as Trump went for further tariffs specifically addressed at China. The threat of reciprocal action from China materialised after the end of the quarter.  The Facebook scandal and Trump's attacks on both the tech sector and Amazon in particular did not help sentiment at the end of the quarter.

Turning to the UK, Brexit negotiations which had progressed to phase two at the end of last year, moved on again with agreement on many issues and a timetable for transition. There was an attempt from both sides to present the progress made in a positive light.  However many of the most difficult issues, such as the Irish border, remain to be resolved.  With some progress made and with the BoE looking to raise rates again, the pound strengthened, particularly against the US dollar. The strength of sterling weighs on overseas earnings of UK listed companies and the FTSE 100 Index fell more than other developed markets.

In Europe, Merkel finally managed to form a government six months after the German election. In Italy, the anti-establishment Five Star movement did well in the election but with no overall majority, forming a government will be as difficult as we expected before the election. In France, President Macron is struggling with the unions to push through his reform agenda. To conclude, despite the current political state in Europe being turbulent, the European economy has been recovering and unemployment falling which should be positive going forward.

As we look out into the rest of the year, Trump's protectionist policies and their impact on global trade are the greatest unknown. His advisors have indicated that they are pursuing trade deals and this may all turn out to be a negotiating stance. A global trade war is in no one's interests and the pressure will be on all parties to resolve their differences. It is important to remember that the economic background and corporate earnings growth remains broadly positive.  While interest rates in the US and the UK have been moving up, this is a slow process. The BoE suggested that it will be at "a gradual pace and to a limited extent". Trade wars aside, this is a generally constructive background for equity markets.  It is always difficult to be positive at times like this but with a price earnings ratio of 13 and dividend yield of 4.3% on the FTSE All-Share Index, a lot of bad news appears to be priced in.  As the uncertainties persist we should expect more periods of volatility and while we remain positive on equity markets, we will continue to monitor the situation closely.