Economic Outlook for March 2018
In our previous monthly economic outlook we highlighted the high probability that volatility could not remain low for very much longer. We advised investors to expect a short-term price correction in 2018 and to be prepared to maintain invested levels in the face of any decline. We did and continue to believe that strong underlying economic fundamentals and corporate earnings growth support equity valuations. At the beginning of February the markets did exactly as we had predicted.
Following six-months of record low volatility and stable positive equity markets, volatility spiked to extreme levels and global equities declined, the S&P peak-to-trough decline was more than 10% in a week. The cause of the shift up in volatility and negative equity market price correction is still being debated. In our view, the cause is less important than the implications of the change in market environment. Our prescience aside, we view this change in market environment as a normalisation of equity markets back to healthier levels of volatility and price trajectory. In other words, we have shifted out of an abnormal period of low volatility and stable returns and into a market driven by economic fundamentals.
It is no coincidence that the past four weeks of higher volatility have also been a period of strong outperformance of Dominion’s actively managed strategies over index benchmarks. Low volatility and high correlation between stocks benefits passive investment strategies; everything goes up at the same time with no-one losing. This was always an abnormal and unsustainable market environment. The implication for investors of this shift in equity markets is important. While we do accept that much larger market price corrections can and will happen in the future, we view the recent shift in markets as a healthy dose of reality for equity markets and a return back to economic fundamentals and valuations driving equity prices. Macroeconomic data and corporate earnings growth are both strong and accelerating ahead of expectations. Investors must look through short-term price fluctuations and remain focussed on what the real economy and stronger corporate earnings are telling them.
Economic Fundamentals Are Still Strong
While global equity and bond markets swung wildly over the past four weeks, underlying global GDP and corporate earnings continued to grow at a strong rate. The macroeconomic data for all major regions posted significant improvements throughout 2017, underlying GDP growth rates and expectations have risen, and this is flowing through into stronger corporate earnings results. As well as higher volatility in markets over the past month, we have also had Q4 2017 corporate earnings announcements, and these have consistently shown robust growth rates (average S&P reported company earnings growth rate 17.5%). More importantly, these earnings results have consistently exceeded expectations. 76.4% of S&P 500 company results reported so far for Q4 2017 have been ahead of expectations. The strong underlying economic data and corporate results continue to support our view that fundamentals support equity valuations, especially for equities with exposure to long-term structural growth trends. The shift in equity markets away from short-term momentum / price speculation and into a fundamentals-driven market will, in our view, further support the case for equity valuations and investing in actively managed equity funds with a focus on structural growth trends.
Risk of Surprise Events Never Went Away
An apt mantra for investors to think about the risk of surprise events in equity markets might sound like: “Don’t forget that Donald J. Trump is the President of the United States of America.” As quickly as global markets digested the surprise election win of an unpredictable and highly volatile man to the highest political office in the West, those same markets appeared to shrug-off the risk of him doing any of the things he promised he would do. On Thursday 1st March, Mr Trump did something he said he was always going to do, namely to announce tariffs on imports of steel and aluminium, a clear targeting of Chinese exports of these goods to the US. Volatility spiked and equity markets sold-off on the news. The implications of this move by President Trump are still unclear. A response is likely from the WTO as well as from the EU and China. A trade-war is a possibility, which could impact global trade flows and global GDP growth. That is bad for everyone, including Donald J. Trump, and would in our view most likely result in a quick political compromise between the major global trading blocs. Either way, global markets and investors have been given a stark reminder that the risks inherent in a Trump Presidency never went away.
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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.