Chief Investment Officer
It has been a busy few days for IMF staff, policymakers and academic think-tanks following the October update to the IMF World Economic Outlook where GDP estimates were revised up (3.7% in 2017, and 3.8% in 2018) and advanced economy inflation was revised down. Nominal wage growth remains lower than before the Great Financial Crisis and this is attributed to labour market slack, subdued inflation expectations and slower productivity growth but there has been little debate about whether this benign background will persist. US core inflation surprised on the downside last week but more people than ever before have jobs, average hourly earnings are running at 2.9% but perhaps most importantly producer price pressures in China are likely to feed through to the global supply chain at some point. The US bond market reaction last week was to edge back the probability of the next US rate rise in December to 72% and 10-year bond yields eased to 2.3% but this raises the risk that markets are still behind the interest rate curve if growth does surprise materially on the upside. European yields also eased on ECB President Draghi’s comments suggesting that progress towards the inflation goal was not yet sufficiently convincing. There is plenty of data in the pipeline this week to keep economists busy and in the UK we shall be watching CPI, wages and retail sales for confirmation of whether inflation is temporary, pay rises remain elusive and consumers are exerting some caution in their pre-Christmas purchases. But the focus is on central banks: Bank of England Governor Carney’s recent speeches suggest that the UK economy is running out of spare capacity indicating a November rate rise is a ‘done deal’ even while the economic date softens. Perhaps more important for future global monetary policy is the anticipated decision from US President Trump on the next Federal Reserve Governor: Jerome Powell is currently the bookies favourite and would represent policy continuity.
Global stock markets continued their upward march last week, with the FTSE 100 closing at an all-time high on Thursday. Japan’s Nikkei 225 Index also pushed above 21,000 for the first time in 21 years (although those with a longer memory should remember that the all-time high was 38,000 achieved in 1998). There is much debate about the seemingly relentless rise in share prices seen this year, especially after a good 2016, but with the global economy enjoying its most synchronised growth phase since 2010, there is fundamental support for the rerating of markets. It should also be remembered that valuations today when compared with the past need to take account of interest rates and the fact that prevailing bond yields are much lower than they were ten years ago. There is also very little sign of the euphoria that typically accompanies the later stages of a bull market (remember the dotcom bubble when every taxi driver would give you a stock tip).
What, therefore, might upset markets? Geopolitical tensions are never very far away and a major military conflict involving nuclear weapons could clearly destabilise the global economy. Another global financial crisis could cause a rout in stock markets. A sharp rise in interest rates could hit bond markets hard, derailing equities. There are also concerns around about the high level of unsecured borrowing that individuals have committed to in recent years and their ability to cope with rising interest rates. A common factor in this debate is the prospect of higher borrowing costs. At present, central banks remain very accommodative in terms of monetary policy, even though both the US and UK central banks are talking about raising rates within the next couple of months. However, with global inflation remaining fairly benign, it seems hard to ponder a set of circumstances whereby interest rates are likely to rise by such an amount that they would severely damage markets. Therefore, as long as the economic recovery remains intact, and inflation remains relatively benign, stock prices can continue to make progress from here.
This commentary has been prepared for information purposes only and is not a solicitation or an offer to buy or sell any security. It does not purport to be a complete description of our investment policy, markets or any securities referred to in the material. The information on which the commentary is based is deemed to be reliable, but we have not independently verified such information and we do not guarantee its accuracy or completeness. All expressions of opinion are subject to change without notice. Investors should remember that the value of investments, and the income from them, can go down as well as up and that past performance is no guarantee of future return. Quilter Cheviot is the trading name of Quilter Cheviot Limited, a private limited company registered in England with number 01923571, registered office at One Kingsway, London, WC2B 6AN. Quilter Cheviot has established an office in Dublin, Ireland with number 904906, is a member of the London Stock Exchange, is authorised and regulated by the UK Financial Conduct Authority, is regulated by the Central Bank of Ireland for conduct of business rules, under the Financial Services (Jersey) Law 1998 by the Jersey Financial Services Commission for the conduct of investment business in Jersey and by the Guernsey Financial Services Commission under the Protection of Investors (Bailiwick of Guernsey) Law, 1987 to carry on investment business in the Bailiwick of Guernsey. Accordingly, in some respects the regulatory system that applies will be different from that of the United Kingdom.