New article from Tatton Investment Management: Consolidated base but momentum dwindling

4 August 2017

It’s been another week where political dramas have dominated the headlines, whether it was Trump’s revolving doors for his senior staff in the White House, Germany’s car builder summit to save the diesel engine or never ending Brexit positioning. However, for the global investment community, a raft of data releases made the week far more substantial.

Over 70% of Q2 corporate earnings announcements have been published and the results are encouraging. Average annual profit growth (EPS – 3rd line in table below) has been solid and in all cases at least 10%. This is not quite as strong as the first quarter, but that measured against a much weaker starting position of the ‘crash Q1’ of 2016. These results justify risen and elevated equity valuation levels somewhat, but most importantly consolidate the corporate earnings picture, in the sense that they prove the previous two quarters were not just flash-in-the-pan type episodes.

This impression was further underpinned by solid readings of forward looking economic indicators (PMIs), which tell us with some certainty that the synchronised global economic expansion remains on track, with all major regions reporting expanding activity levels. The only exception appears to be India, where businesses are struggling to digest the major change in the tax system – as we reported a couple of weeks ago.

What slightly spoils the broth is that there are very little signs of further acceleration. Positive growth? Yes. Indications of accelerating growth levels? No. And this is evident in both, the macroeconomic PMI levels as well as the corporate outlook statements.

We appear to have reached a fragile Goldi-locks equilibrium, where the status-quo is satisfactory but not exciting, and where there is also nothing much to excite on the horizon.

Nevertheless, equity market investors, particularly in the US, were pleased about the lack of disappointment and pushed indices in some instances to new highs. Overall, however, better results did mostly not result in surging stock prices. It would appear there is some further concerns in the air.

That would be the declining bond markets, where yields rose on the improving economic resilience and the prospect that central banks will gradually be reducing their QE-induced bond stock piles, as there is less and less justification for the continuation of extraordinary monetary stimulus measures.

If the prospect of potential bond market stress is keeping investment strategists nervous, then the North Korea tensions are making all those with additional political radar even more nervous. The Trump administration’s ramping up of trade repression rhetoric towards China is, in the opinion of political insiders, really aimed at ‘encouraging’ China to put more pressure on its northern neighbour and previously close ally. We discuss this situation in detail in our second article this week, and explain why it is possibly more worrisome than it may currently seem.

In the UK, the Bank of England’s decision to keep rates at their ultra-low levels, together with their explanation why, informs us that the first rate rise of this decade is still beyond the next 12 months’ horizon. We take the opportunity in the third article to look at the various economic parameters the rate setters at the UK’s central bank consider.

Back to global finances. Our guest economist Duncan O’Neill and our head of investment Jim Kean discuss in the fourth article why the four rate rises that the US central bank has already applied have not led to a tightening of financial conditions and why it is therefore probable that central banks will use the unwind of their QE positions to a larger extent than markets currently anticipate. This would also explain why some monetary policy heavy weights like longtime Fed chair Alan Greenspan are sending fairly explicit warnings to bond investors to brace for losses.

Finally, in our fifth article we continue with our series about the technology mega companies Amazon, Apple, Facebook, Google/Alphabet and Microsoft and discuss their significance for the future global economy.

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