Economic Outlook for June 2018
Since last writing in May, global equity markets have posted a solid price rally, supported by continued strong economic data and a strong set of Q1 corporate earnings. The S&P 500 is up +5.1% since the beginning of May, corporate earnings data was well ahead of expectations in Q1 2018, and macroeconomic data in the US and China has continued to be very strong. Concerns around geopolitical events continue to linger, however these risks are arguably no different to the risks that have always faced the global economy. The key question with respect to geopolitical risk is will any of those events have a major negative impact on equity markets? We don’t think so. There is nothing new about any of these issues, whether it is the latest populist government in Italy, or Trump’s latest spat with China over trade. The world is actually a safer and more prosperous place today than it has ever been in the past. Geopolitical risk is a real thing, but we would argue it is nothing to lose sleep over. Meanwhile, the macroeconomic picture is rosy, corporate earnings are strong, new technologies are revolutionising the world and living standards have never been better. There will always be negative news headlines. That is what newspapers are incentivised to do (even the financial press). The job of active equity managers is to look through the news-flow and understand the underlying trends. Those economic and technological trends are positive for the world economy, particularly so for equities exposed to long-term structural growth trends.
Our advice through 2018 has been to remain calm in the face of more volatile markets, negative news-flow related to geopolitical events, and to remain laser focussed on the strong underlying economic fundamentals of the global economy, which will support equity valuations. With respect to the positive macro picture, since 2017 nothing has changed and this is good for equity valuations. What has changed since 2017 is the market regime. The new dynamic in global equity markets is that a strong equity market will not necessarily benefit all stocks any more. The collapse of the short volatility trade in Q1 2018 and normalisation of equity market volatility, combined with the slow but steady return to normalisation for monetary policy in the US (likely to be followed eventually by the EU, Bank of England and Bank of Japan) means that the time for easy money has come to an end. This favours active equity investment management strategies to outperform passive in the new market environment, after a decade of passive outperformance of active. So far in 2018, this view has been supported by the strong outperformance of Dominion’s actively managed investment funds against the market benchmark. We continue to believe this new market regime will continue for some time, likely many years, and investors should be cognizant of the importance of choosing the right equity investment strategy in this new environment.
Latest Macro Data is Strong
The latest macro economic data releases for Europe, the US and China have been strong. There are signals of acceleration in the growth of the US economy to even higher levels than we have seen in 2017, economic confidence levels there have touched new highs and underlying real economic activity clearly improved in April and May. US adjusted retail sales data in April accelerated to +4.1% YoY, industrial production is close to +4% YoY, and the latest PMI readings all indicate strong expectations of expansion across the US economy. In China the latest data releases have all been strong, pointing to a strong underlying economy, which has shown some signs of acceleration in recent months. Electricity consumption in China increased +7.8% YoY in April, a strong acceleration over the Q1 average, export trade data has improved in recent months and the latest PMI readings also indicate strong expectations of expansion across the economy. These latest data readings continue to show a positive macro picture for the global economy.
Geopolitics – Keep Calm and Carry On
Geopolitical risk is as old as civilisation. It has never and will never go away. The financial press and 24 hour news channels are incentivised to exaggerate bad news, that’s what pays their bills. Whether it is the latest tweet by the US President, North Korea’s latest missile test, Brexit, China-US trade tensions, the Iran nuclear deal or the on-going tragedy in Syria, one would think based on the news coverage that the world (and the equity bull market with it!) is coming to an untimely end. What the headlines do not tell you is that the world is in fact the most peaceful it has ever been in human history. Global levels of disease, poverty and violence have never been lower than they are today. Levels of economic activity and income per person have never been higher. The global economy is entering its 10th consecutive year of strong economic growth following the Great Recession, and there is no indication of this positive trajectory stopping any time soon. New technologies are revolutionising medicine, commerce, communications, entertainment and travel. Every industry in every region is being transformed by an unprecedented wave of innovation. Far from the end of days, the world today is one of incredible investment opportunities to invest in the future. Geopolitical risks are real, there could be an escalation of conflict in the Middle East, there could be a full scale trade war (or worse) between the US and China, but these are risks which have always been there in the background, and statistics indicate that these types of event are actually less likely to occur now than any time in the past. Monitoring these risks is important and will always remain so, however investors should look through the negative tone of international news and be optimistic, the world is changing for the better and that offers unique investment opportunities to invest in that change.
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The views expressed in this article are those of the author at the date of publication and not necessarily those of Dominion Fund Management Limited. The content of this article is not intended as investment advice and will not be updated after publication. Images, video, quotations from literature and any such material which may be subject to copyright is reproduced in whole or in part in this article on the basis of Fair use as applied to news reporting and journalistic comment on events.