Chief Economist and Head of GAM Investment Solutions, Larry Hatheway, comments on the outlook for markets, his expectations for monetary policy and the biggest risks to investors in the next quarter
Chief Economist and Head of GAM Investment Solutions, Larry Hatheway, comments on the outlook for markets, his expectations for monetary policy and the biggest risks to investors in the next quarter.
The twin moves we have seen in capital markets over the past nine months – rising share prices and rising bond yields – seem set to continue, but we should expect market performance to also change. The speed of the movements is likely to slow and pauses are likely to become more frequent. Within equities, in particular, we should see more geographic rotation, on evidence that earnings are improving, above all in Europe, emerging markets and to a lesser extent Japan.
Expectations for monetary policy are predicated on the arrival of an inflection point. That was signalled over a year ago by the Federal Reserve as it began the process of normalisation, underscored by its rate hike in March. If political risk abates in Europe after the French elections, as we expect, we are likely to see the European Central Bank move in the same direction. It is likely to adopt a more neutral policy stance, including tapering and perhaps even removing negative interest rates. The combined actions of the Fed and the ECB are likely to precipitate further increases in bond yields later this year, consistent with a broader normalisation of monetary policy in the world economy.
Investors have focused primarily on political risk, given the shocks that arrived in 2016 – namely, Brexit, the US elections and the Italian referendum. It is therefore understandable that markets will remain focused on politics in 2017, given the uncertainties around the French elections and possibly those in Germany in the autumn. However, in our view, the twin risks that bear close attention are more familiar ones, including the possibility that inflation might accelerate more than is commonly believed, particularly in the US, as it nears full employment. The second risk is China. Credit growth is beginning to slow and the credit impulse is turning negative, which portends weaker growth later this year. China growth fears have not been at the forefront of investor concerns for over a year, but it is worth recalling that concerns about China precipitated the two largest market setbacks seen in the past eighteen months. We overlook China at our peril.
In our portfolios, we remain overweight equities, with a preference for Europe, emerging markets and parts of Japan. In fixed income, we remain comfortably short of duration. We see opportunities in subordinated debt structures and debt instruments that we believe should generate positive and steady returns, including mortgage backed securities. Overall, we retain a preference for ‘reflation positions’ but we are beginning to shift allocations toward positive earnings surprises and away from multiple expansion as a potential source of positive returns.