Market Quick Points - Q3 2017

A collection of key macroeconomic themes and market trends that bear watching.

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Backdrop

  • Solid global growth continued through midyear despite a somewhat tepid US expansion. China’s growth has surprised to the upside while Europe continues to gain traction.
  • Despite two straight quarters of very strong earnings growth in the US and Europe, valuations remain stretched by historical standards.
  • Credit spreads remain very tight amid record-low volatility in equities and bonds and upbeat corporate earnings. Investors are increasingly asking themselves whether they are being adequately compensated for the risks they are taking in credit markets. Uncertainty around North Korea’s nuclear program serves as a reminder that volatility could return, potentially undermining risky assets.
  • A weaker US dollar has provided US multinationals with a significant tailwind.
  • Global central bank policy appears to be in transition from an ever-looser stance to a more neutral one. The US Federal Reserve (Fed) has hiked rates a total of four times since December 2015 and is set to begin allowing Treasuries and mortgage-backed securities held on its balance sheet to mature starting this autumn. The European Central Bank could announce its intention to taper asset purchases around the same time.
  • Labor markets continue to tighten around the developed world, but wage growth remains subdued. However, productivity growth remains low.
  • Improved global growth, stable commodity prices and a weaker US dollar— along with receding fears of US protectionism— have supported strong emerging markets inflows.
  • Globally, growth stocks have outperformed value stocks by more than 9% on a total return basis through July amid an economic growth trend that remains below pre-crisis levels despite recent strength.

Outlook

  • Waning US inflation pressures call into question the Fed’s plan to hike rates again before year-end.
  • Populist movements in Europe have lost momentum, and Angela Merkel appears poised to win a fourth term as chancellor of Germany in late September. However, the exact makeup of the Christian Democratic Union–led coalition remains an open question.
  • Improved Eurozone growth appears to be broad-based, with survey data showing optimism extending well beyond Europe’s core.
  • While the Trump administration has had little success passing a pro-growth agenda through Congress it has had a measurable impact on the regulatory environment, with reduced red tape contributing perhaps as much as 0.2% to GDP growth.
  • After years of underperformance, emerging market equities have finally outperformed equities in developed markets this year. Valuations for EM are cheaper, which is not surprising in light of the higher level of risk in emerging markets.
  • A weak pound sterling is crimping UK consumer demand but it is also providing a tailwind
    to earnings for British multinationals.

Risks

  • With markets “priced for perfection”, even modest earnings shortfalls could undermine market confidence
  • North Korea’s accelerating quest to develop nuclear missiles capable of reaching the US put markets on edge at mid-summer and looks likely to be a potential source of market volatility in coming months. With volatility at historically low levels in recent months, any unwinding of highly-leveraged positions designed for less volatile circumstances could amplify potential market instability.
  • US pressure on China to rein in North Korea has the potential to put strains on trading relations between the world’s two largest economies. Any trade disruption could have ripple effects around the globe.
  • While markets expect the Fed’s balance sheet normalization program to run smoothly, removing liquidity from the system could apply some upward pressure on yields. Conversely, the long-term outlook for both growth and inflation remain weak amid structural US and global headwinds such as extraordinarily high levels of debt, unfavorable demographics and the disinflationary effects of globalization and technological advances.
  • The approaching end of the US government’s fiscal year on 30 September means that budget and debt limit legislation must be enacted within a short window to avoid market disruption.
  • Hopes for comprehensive US tax reform are fading though there remains the potential for a package of modest tax cuts.
  • China has fostered market stability in advance of the 19th Congress of the Communist Party this fall. Nevertheless, there is concern that fiscal policy has been front-loaded in advance of the gathering and that growth could falter at the end of the year.
  • The Japanese economy has thus far shrugged off charges of cronyism against Prime Minister Shinzo Abe and members of his cabinet, but Abe’s economic revitalization efforts could be endangered if the scandals empower the Liberal Democratic Party’s fractured political opposition.

 

 

The views expressed are those of MFS and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation to purchase any security or as a solicitation or investment advice from the Advisor.

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