January on the whole saw economic data releases that were consistent with key economies either having entered expansion phase or approaching it. Unemployment rates either stayed steady as was the case in the US, UK and Europe or rose as in Japan. While there is still scope for rates to fall further, as we close in on the end of the cycle we are likely to see more months where they do not fall or indeed may begin to rise. That said, in Japan’s case, the slight rise in unemployment is no cause for concern given that the dominant trend is an increase in the size of the workforce as more and more women join it.
"Cash is yet to provide competition for risk assets"
The period of global economic strength that began in 2016 is now clearly evident. Real GDP growth rates in the US, Europe and Japan are now all 1%pt higher than they were back in the first half of 2016. Only in the UK has there been some slippage, perhaps reflecting the impact on real wages and thus consumer spending of the higher inflation induced by sterling’s fall in the wake of Brexit. It certainly seems to be taking some time for the benefits of the weak currency on the external sector to be feeding through, this is not entirely unexpected.
Inflation data released in January were mixed. In terms of headline CPI, Japan’s rose, and the UK’s fell which were both welcome developments as it had been too low in the former and too high in the latter. But Europe’s fell to 1.3%, an indication that deflationary forces there are still prevalent. That said, the more important core inflation numbers painted a better picture, with all but Japan showing either a fall towards the comfortable level of 2% or a rise towards it (in Japan it was steady).
In emerging economies, inflation generally rose slightly. This is something to watch closely, though rates are still well below the point at which they indicate a threat rather than just buoyant economies.
As for financial markets, January saw the dollar’s decline accelerate and bond yields rise sharply in major developed markets. The former may be due to the perception that the recent tax cuts in the US may be the start of a trend of declining fiscal discipline, or perhaps the expectation that although there are more interest rate increases on the way in the US, there are more on the way in other economies, the UK being a case in point. As for the rising bond yields, it is possible that markets are catching on to the fact that inflation may continue to rise and that real rates were low anyway.
In the UK, longer dated LIBOR yields crept up, perhaps reflecting the fact that although not imminent, further interest rate hikes are on the way.
Equity markets were generally buoyant in local currency terms but in US dollar terms were particularly strong given the dollar’s fall. Commodity prices were also firm, but this was due more to dollar weakness than to a rise in real prices.
The march towards the peak in the global economy continues and there was nothing in January to suggest otherwise. It is true that equity market yields are a lot lower than they were five years ago but they are still well above historic lows so have scope to fall further. It should also be noted that cash is yet to provide competition for risk assets, given that real short-term interest rates remain low or negative. We reduced our funds’ equity weights further in January and expect to continue to reduce them for the next two or so years.
Published in Investment Letter, February 2018
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.