Trump trade war threat
A continued world recovery, led by the US with good support from Chinese growth among the emerging markets, is a positive backdrop for share markets. The Trump tax cuts and spending increases could boost US demand and output with the upcoming earnings season in the US likely to be the strongest since 2010.
Yet if Donald Trump pursues both China and the EU to the full extent of his threats, we expect this would slow world economic growth by about 0.5% – currently we expect global growth of around 3% without the impact of tariffs.
Should matters escalate and the US unleash a full-blown trade war, the scope and impact of rising tariffs could be more formidable. The effect on world growth would be more considerable. However, we believe it is likely President Trump will wish to do a deal with China and declare a “win” in good time for the mid-term elections in November, which would put an end to the turbulence.
Where are the best opportunities?
We expect to see reasonable returns in global equities in the next year but this is unlikely to exceed single digit growth. We particularly favour the US, where encouraging expansion in company earnings has reduced the premium rating of the market, and future progress seems underpinned by the wealth of technology stocks.
The recent sell off in some emerging markets, adversely affected by trade war threats and by a stronger dollar, also seems to present an opportunity. On a one-year view Asian emerging economies appear resilient and their equities good value.
The picture for the UK equity market looks to be improving, albeit with much uncertainty in the form of Brexit negotiations. The UK is relatively cheap and under-owned by global investors, but the UK economy continues to generate more employment and is now experiencing rising real incomes again. The movement of the pound in currency markets will continue to be an important factor. Sterling weakness tends to boost the value of large companies who earn much of their income overseas in other currencies, but strength in the currency implies pressure on such shares.
As the Bank of Japan continues with a loose monetary policy at a time of US tightening we expect to see further weakness in the yen. Coupled with corporate reform and relatively low valuations ascribed to Japanese shares it could mean further gains.
We are less positive on Europe given political issues in Italy. The new government wishes to set an expansionary budget, cutting taxes and increasing spending. This could result in a dispute with EU and euro area authorities. Should the situation escalate, it could damage European markets. On balance we expect there will be a negotiated resolution before things get out of hand but it is likely to impede the progress of European markets in the meantime.
In addition, we have identified several emerging economies where a combination of a weak currency, poor economic policy and the need to raise interest rates poses problems. Any emerging country with a weak balance of payments and high external debt is vulnerable as the dollar rises with US interest rates. However, the large emerging economies, particularly in Asia, which have good balance of payments positons and modest overseas debt still look well placed for growth. The difficulties are largely concentrated in countries such as Argentina, Turkey and Venezuela.
Central bank action remains important
It is possible that the Bank of England will increase interest rates in August. The US is likely to increase interest rates further over the course of the year, but we anticipate this will not be in a damaging manner. Japan will likely continue with an accommodative monetary policy, and we believe the euro-area should adopt a progressively less accommodative stance as we head into next year.
In general, these Central Bank interest rate policies are well priced into the market, and with inflation expectations quite stable the conditions for bond market remain fairly benign. However there are few compelling opportunities in the asset class given current prices.
Slowing money growth in several parts of the world could hit output. Chinese money supply growth has slowed, as authorities seek to reduce bad loans and cut lending. UK money growth has been slowed by Bank of England action to reduce consumer credit, cut car loans and some mortgage lending. US money growth has been slowed somewhat by interest rate rises. Our base case assumes the central banks will not wish to slow money growth to the extent that it undermines growth.
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