Choppy waters

We have made it through the first half of what some would describe as a fairly challenging year. There have been turbulent markets, trade tiffs and political pantomimes – but let’s not forget that we have also enjoyed a long hot summer and spirits were boosted by World Cup hopes (depending on who you supported). So what do we think the rest of 2018 might have in store for investors?

Global Outlook

As we write, global economic growth still looks broadly healthy and corporate earnings are robust, which should continue to support risk assets like equities. As always though, there are headwinds and further caution is required.

Trade tiffs and tit for tat

At the beginning of the year, optimism was high that 2018 would deliver the strongest global growth since 2011, supporting another solid year for returns for investors. However, that optimism has been tested by several factors, not least President Trump’s creeping protectionism and trade sanctions. Initially focused on China, these widened to include other major trading partners such as Germany, Japan and Mexico.

This has seen the Trump administration announce new duties on products ranging from steel and aluminium, to washing machines and solar panels, as well as more than 800 Chinese products, covering everything from aircraft, to chicken incubators and industrial magnets. These have been met with a host of retaliatory measures. August also saw President Trump re-impose trade sanctions on Iran and tweet a warning to other trading partners that “anyone doing business with Iran will NOT be doing business with the United States”. This has complicated the relations that many nations have with Tehran. Understandably, all this trade to-ing and fro-ing has increased fears of a breakdown in global supply chains.

US/European trade relations did thaw over the summer, when President Trump hosted European Commission President Juncker in Washington. They agreed a deal to lower industrial tariffs, work towards zero tariffs and resolve the previously imposed duties on aluminium and steel; helping diffuse some of the rising transatlantic trade tensions. However, as we approach US mid-term elections, there are growing concerns that President Trump will be incentivised to follow through on more of his threats.

What does this mean for investors? Well, as long as an all-out trade war is avoided these tensions should not derail the global economic expansion. However, President Trump’s communication style and negotiating tactics will likely continue to affect investor sentiment and spark bouts of market volatility.

When we stand back from the noise, there are still reasons to be optimistic about the economic outlook

Political pandemonium?

We talked last time about potential political flashpoints for 2018 and the first half of this year certainly saw its fair share of fireworks. After escalating tensions and the exchange of insulting tweets between President Trump and Kim Jong-un, we were treated to an on/off, on again run-up to the historic and somewhat surprising US/North Korean summit in June. What was actually agreed between the leaders at the meeting remains sketchy and some months down the line both parties seem to have quite different ideas of what the denuclearisation of the North Korean peninsula might look like. Like the rest of the world, we will closely watch how this purported diplomatic breakthrough plays out.

In spring, the Italian elections proved a tumultuous affair and were a reminder of the EU’s vulnerability to disruption and discord. After more than three months of administrative limbo, we eventually saw the formation of the country’s first populist, Eurosceptic coalition government. Since its investiture, Eurozone investor and business confidence data has softened; a reflection that the policies of this administration are likely to be more unpredictable than the previous pro-business, reformist Europhile government. Although support for the euro is lower in Italy than most other countries, the risk of Italian exit from the currency union looks low in the short term – the European Central Bank (ECB) designed its Outright Monetary Transactions (OMT) programme to prevent an accidental exit, while the institutional barriers to a legal referendum and exit are also high.

The UK’s future relationship with the EU, meanwhile, still remains highly uncertain as the Article 50 deadline of March 2019 approaches. The situation has not been helped by the resignation of a number of high-profile ministers including, Foreign Secretary Boris Johnson and Brexit Secretary David Davis. These followed the cabinet approval of Prime Minister May’s template for a softer Brexit. Yet, despite its messy politics, the UK economy continues to tick along, with particular strength in the services sector, the lowest unemployment since 1975 and decent wage growth. However, Brexit will continue to cast a shadow for the foreseeable future and developments around the negotiating table are likely to be critical to asset values, gilt yields and the direction of sterling.

A testing time for rates

Another issue to consider as 2018 plays out is the change in global monetary policy. Central banks have started to unwind quantitative easing and raise interest rates. This includes the Federal Reserve (Fed), which has hiked rates four times over the last year, with four more expected next year, and the Bank of England, which raised UK rates in August for only the second time in a decade.

Some have argued that the Fed has been too slow to start tightening interest rates and that it will have to hike more aggressively should inflation start to rise rapidly. The US government’s $1trillion tax cut, at a time when the economy was at full employment could certainly manifest itself in rising prices, necessitating the Fed to act forcefully. Higher rates and global inflation fears could also push up costs for consumers and businesses, curtailing spending and business investment.

A bumpier ride ahead

As a result of these factors, navigating markets has become more difficult over recent months and they are likely to be choppier for the remainder of the year. However, when we stand back from the noise, there are still reasons to be optimistic about the economic and investment outlook.

Critically, the build-up of headwinds we have highlighted should be set against a number of healthy cyclical dynamics, not least continued strength in economic data, a robust corporate sector and largely accommodative financial conditions in the major economies, which should see them continue to grow at or above trend this year and next.

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