May Investment Outlook

5 May 2017 

Diminishing hopes Trump will deliver fiscal stimulus package, UK stages General Election, and Emmanuel Macron storms to victory in the French Presidential election.

Politics has continued to dominate market sentiment early in the second quarter of the year. Markets breathed a sigh of relief as the reformist, pro-EU Emmanuel Macron stormed to victory in the French Presidential election, comfortably defeating the anti-Euro Marine Le Pen.

As Donald Trump completes his first 100 days in office, markets are continuing to question the President’s ability to deliver the promised fiscal stimulus measures aimed at boosting economic growth.

In the UK, Theresa May surprised both markets and many in parliament by calling a snap general election. The Prime Minister hopes to substantially increase her majority and personal authority ahead of key Brexit negotiations with the European Union this year.

 

Europe & UK outlook

We remain encouraged by evidence that a cyclical recovery in the eurozone is, at long last, now developing. Leading indicators point to better growth in the second quarter and, against this backdrop, corporate earnings have continued to improve. However, domestically driven inflationary pressures in the region still remain subdued. Core inflation has picked up to 1.2% but still remains at historically low levels. ECB president Mario Draghi continues to resist pressure from within the Governing Council for a more rapid taper of the ECB’s asset purchase programme, or an increase in the deposit rate; for now at least.

We remain encouraged by evidence that a cyclical recovery in the eurozone is, at long last, now developing. Leading indicators point to better growth in the second quarter and, against this backdrop, corporate earnings have continued to improve. However, domestically driven inflationary pressures in the region still remain subdued.

Core inflation has picked up to 1.2% but still remains at historically low levels. ECB president Mario Draghi continues to resist pressure from within the Governing Council for a more rapid taper of the ECB’s asset purchase programme, or an increase in the deposit rate; for now at least.

The eventful chapter in British politics continues and the UK stages a General Election on June 8. The Prime Minister is seeking to take full advantage of the Conservatives’ strong lead in the polls and increase her majority in the House of Commons.

Sterling rallied strongly on the announcement, perhaps on the view that Theresa May will have greater scope (and time) to reach a transitional deal with the EU and avoid a cliff-edge Brexit scenario in two years’ time. Should she increase her majority, as opinion polls suggest, Mrs May could also reduce the influence of the hard-line Eurosceptics within the Tory ranks, increasing the chances of a ‘softer’, and more pragmatic Brexit.

The tone of the negotiations will be a key focus for markets and is likely to continue to dictate the direction of sterling as the year progresses. For the UK economy, a stronger (or more stable) currency could begin to feed into the Bank of England’s inflation forecasts. A more stable sterling will help reduce imported inflationary pressures.

Although consensus GDP figures have moved higher (1.8% for 2017), 10-year gilt yields (seen as a proxy for economic growth) have remained at low levels, reflecting the still uncertain economic outlook in the UK. Meanwhile, there is some evidence of the squeeze on disposable incomes impacting consumer spending. This remains a key headwind for the UK economy this year, and, as a result, we continue to believe the MPC will keep monetary policy accommodative.

US equity outlook

The Trump administration finally released some details of its long awaited tax reform plan on April 26, but the plans were long on ambition and short on detail.

Proposals included aggressively lowering corporation tax and incentives for US companies to repatriate some of the $2.6tn held in cash overseas. Without a notable increase in the US economic growth rate, the tax cuts look likely to substantially increase the US budget deficit over the next decade.

This is a highly contentious issue for a divided and fiscally hawkish Congress, with the US government debt-to-GDP ratio already close to 80%. The subdued market response to the announcement perhaps reflects skepticism such aggressive tax cuts will successfully be enacted, and in a timely manner.

President Trump’s plan is a starting point for what is likely to be a period of protracted negotiations between his team and Congress. A watered-down, and delayed, version of the tax reforms looks a more likely outcome, and any positive impact on the US economy from this could be pushed out well into 2018. Treasury Secretary Steven Mnuchin has also conceded the possibility that tax cuts may be temporary.

US GDP growth in the first quarter was weak (0.7), and with markets losing patience with Trump’s ability to stimulate the economy, we may need to see a strong rebound in the second quarter data to help reignite the reflation trade.

 

 

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