Although April saw equity markets look a little perkier, following a period of weakness that began in mid-January, it also saw safe haven bond yields pushing higher again. Specifically, the US 10-year Treasury yield breached the psychologically important 3% mark, though it fell back below that level towards the end of the month. Such behaviour is indicative of decent economic growth that would be good for equities but negative for bonds. This was indeed the case, though signs began to emerge that the period of economic strength that began back in 2016 is becoming long in the tooth.
"This has been a de facto tightening in monetary conditions"
In the UK, three things caused sterling to be weak as well as interest rates at both ends to fall back in the second half of the month. First, inflation data was weaker than expected. Second, following this data, Bank of England governor Mark Carney announced that a May rate hike was far from certain. Third, first quarter growth was also weaker than expected.
Although many will have blamed the weaker-than-expected growth and inflation numbers on Brexit fears, I think the more likely culprit is the strength in sterling over the last year or so. This has been a de facto tightening in monetary conditions which may well have nullified the need for a rate hike in May. However, currency strength is often a one off, and I think the underlying trends in growth and inflation warrant further interest hikes this year. In other words, we are still very much in a tightening cycle that began in November last year, even if the take-off is, as it has been in the US the last two and a half years, a slow one.
As for growth globally, I noted last month that there were signs it was peaking. The OECD global leading indicator is still rolling over, while purchasing manager indices announced in April suggested that they were indeed starting to fall or at least level off (I had noted that in a historical context they were in general so high, that they were unlikely to go higher).
Whether or not any forthcoming weakness turns out to be the final intra cycle dip before economies push on to the summit, or the beginning of the end of the cycle, is hard to say. My feeling is that because monetary policy is still so loose, albeit tighter than it has been, and because there is still economic slack in Europe and Japan, as evidenced by low inflation, the global economy has one more leg up.
Elsewhere, the oil price has been particularly strong of late. There are probably a few things at work here. First, if the global economy is as I suspect now well into expansion phase, it is natural to see the oil price and the price of other commodities such as industrial metals rising. Second, we may still be seeing the effects of the supply cut agreed by OPEC and Russia last November. Third, geopolitical risks relating to the Iranian nuclear deal will have pushed up the oil price. Can the price go higher? Absolutely. In inflation adjusted terms the oil price is still well below its long-term trend.
As for the emerging world, although the threat of a trade war has caused markets in China to fall in recent weeks, it is reassuring that China’s economy is still performing well. First quarter growth came in at 6.8% yoy, in line with both expectations and previous quarter, while March retail sales grew 10.1%.
No changes were made to asset allocation targets in April. We expect to reduce equity targets again at the end of May, in line with our road map of a one percentage point or thereabouts reduction every two months for the next 1-2 years.
Published in Investment Letter, May 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.