Return of the ‘old normal’ or calm before the storm?; Central bank monetary policy: Divergence; Emerging Markets Outperform; Intel bets big on driverless cars
Return of the ‘old normal’ or calm before the storm?
The first quarter of 2017, therefore, feels like another one of those rare ‘Goldilocks’ periods, when the stock market climate is neither too warm nor too cold. Compared to last summer, however, returns for bond investors are not as pleasing. And how could they, after last year’s bond rally drove interest income potential for the coming 10 years very close to 0%. For the moment, we are happy that, much as we expected, the feared bond sell-off has not materialised, allowing bond allocations in portfolios to continue to play their role as volatility ‘shock-absorbers’, while equity allocations are contributing positive returns.
When inflationary pressures from the strengthening economy force central banks into a policy reversal we could experience another ‘market tantrum’. Should markets and businesses feel that confidence levels are still too low or uncertainty too high, then overreaction by the economic subjects has the potential to lead to a premature end of the cycle.
Central bank monetary policy: Divergence
In the UK, the BoE’s statement on interest rates last week largely met with expectations – the UK central bank’s rate setters elected to keep interest rates on hold at 0.25%. As we have previously said, economic consensus suggests that consumer spending in the UK is likely to slow later this year (and into 2018), and this view was echoed in the BoE’s announcement. The BoE’s MPC (monetary policy committee) forecast a slowdown in aggregate demand in line with declining household demand growth – itself a reaction to lower real income growth – as rising inflation begins to take effect.
Clearly, the short-term direction of monetary in the UK policy currently appears less clear than elsewhere across the world. Ongoing uncertainty, coupled with an economy that has yet to show concrete signs of sustained activity and growth, suggests that the BoE is right to keep rates on hold (pending the outcome of certain critical events and more sustained economic momentum).
Emerging Markets Outperform
As of last week, however, the MSCI EM Index has already gained another 12% year-to-date, and is 25% up from the same time last year (when the recovery had already begun). It seems that investors are unperturbed by Mr Trump’s protectionist threats of imposing tariffs on imports – something that would no doubt deal a serious blow to US-focused exporters in the developing world. Instead, investors appear to be more concerned with missing out on the return of old EM equity return dynamics, fearing that staying away would see them fail to take advantage of the rally.
Generally, when the Fed tightens interest rates, the US$ increases in value, meaning that dollar-denominated debt held by EM companies (which is substantial, after the extreme borrowing brought on by the low-interest rate era) becomes harder to service. Additionally, tighter monetary policy in the US attracts more capital into the nation, diverting it away from EMs.
Furthermore, we note that the strong performance from EM equities despite apparent headwinds from the US is indicative of a broader point – that these economies are becoming less reliant on the US as their best customer.
Intel bets big on driverless cars
It would seem that big IT companies view AV as a priority, and US technology firms remain cash rich, having $650 billion on their balance sheets. It is possible that Intel’s acquisition could be the start of a ‘gold rush’ into the market by other big players. AV and connected cars look to be a high growth market. One can easily imagine fleets of automated trucks and taxis (and aerial drones?) providing a new high tech and low cost 24/7 transportation network. As the supporting 5G (telecom) infrastructure rolls out over the coming years, numerous tech gurus are foreseeing the next transportation revolution – with similar far reaching consequences for society as the move from horse draws cart to cars at the beginning of the 20th century.
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