Corporate earnings have rebounded globally and the macro data continues to improve, reinforcing expectations that economic growth and inflation rates will keep gradually rising toward what was once the benign norm. Predictions of a correction, meanwhile, have not materialized, which tends to add upward pressure on equities, industrial commodities and interest rates.
During our monthly strategy review at the start of February, we discussed the risk of a major correction in markets. Behavioral finance arguments as well as some more conventional technical and fundamental factors were pointing to a temporary setback. However, the strategy team concluded that the underlying structural supports of the bull market regime remained strong and voted to stay the course, maintaining the overweight in equities and the US dollar.
The decision proved correct. Market turbulences remained shallow, the US dollar recovered, and most major equity markets gained momentum: the S&P 500 in the US has added 3.8% month-to-date, after a 1.8% gain in January. Europe’s Stoxx 600 gained 3.7%, after a 0.4% loss last month. Overall, the MSCI World, representing the developed economies, is up 5.2% year-to-date, while the MSCI Emerging Markets (EM) and the MSCI Asia-Pacific excluding Japan (APXJ) have risen nearly 10%, which is welcome news for our investors, owing to our relatively high strategic position to the EM in general and our tactical overweight in Asia in particular.
Looking ahead, we reiterate our current tactical positioning. In addition to the broader long-term bullish factors that we had highlighted both before (A classic bull market remains a realistic scenario) and after the US election (Beyond the political noise), today we add a few more observations that support our view:
Europe: risks and opportunities ahead
However, with elections due in the Netherlands, France, and Germany this year, European markets may be temporarily driven more by politics in coming months – which need not be a bad thing, despite the prospect for volatile intermezzos. For starters, the widely discussed political uncertainty will probably leave the ECB disinclined to risk premature policy shifts. In addition, the UK Brexit referendum and the US election have shown that the bull regime is not only robust enough to withstand external shocks, but that most investors tend to view these events as catalysts for political changes that will prompt governments to correct policy errors, and ultimately help to roll back deflationary forces and accelerate growth - globally.
However, Europe’s case differs somewhat (charts 5 and 6, p.2): Eurozone growth has already been beating expectations since 2013, making our surprise indicator look toppish. Recent inflation surprises have also been consistently more pronounced than elsewhere. It is thus conceivable that the European Central Bank (ECB) might turn hawkish sooner than generally expected, which could in turn weigh on the macro data and markets, as was the case in the US in 2015, when the US central bank ended is quantitative easing program (the S&P 500 lost upward momentum during that time, gaining only about 3% until the US election last November).
Note: The next LGT Beacon will be published on 8 March 2017.