Global equities register another positive month in March; eurozone bonds decline
March saw Global equities edge higher for a fifth straight month, supported by a continuation of upbeat economic data releases, and a slightly more dovish March FOMC meeting than expected. The MSCI AC World index rose 0.8 per cent. Within DM, US equity indices were little changed, weighed on by uncertainty over the US policy outlook (as the Trump administration failed to pass the American Health Care Act through Congress), as well as lower oil prices due to renewed supply glut concerns. US policy concerns also helped push the US dollar lower against most major currencies, with a stronger Japanese yen contributing to weakness in Japanese indices (the Nikkei edged 1.1 per cent lower over the month). European stocks, however, outperformed, with the Euro Stoxx 50 rising 5.5 per cent, supported by receding political risk concerns following a market-friendly outcome in the Dutch elections. Within EM, the MSCI India and China saw another month of solid gains, whilst the MSCI Brazil fell (-2.6 per cent). Finally, 10-year US Treasuries were little changed, although eurozone equivalents declined (yields rose) amid a slightly more hawkish March ECB meeting, offsetting weaker than expected inflation prints (all data above as of close of 31 March in local currency, price return, month-to-date terms).
US activity remains strong amid greater policy uncertainty
As expected, the US Federal Reserve’s March FOMC meeting saw the federal funds rate increase by 25bp to 0.75 per cent - 1.00 per cent, the third rate hike since December 2015. The median estimate of the Fed’s “dot plot” continued to point to two further 2017 rate hikes, with the projected final destination for US rates remaining little changed at 3 per cent. Further monetary policy tightening this year is consistent with an economy that continues to perform very strongly. February’s nonfarm payrolls release showed 235,000 jobs created, with wage growth continuing to trend higher. Meanwhile, consumer sentiment surveys at multi-year highs signal potential upside to spending going forward. Nevertheless, policy deadlock is a key risk to the outlook, especially in light of the American Health Care Act’s failure to pass through congress. Positively, however, US legislators’ focus now turns towards tax reform and fiscal stimulus.
Eurozone data remains very positive, reflected in a more bullish ECB outlook
Eurozone economic activity data continues to perform well, with the preliminary March composite PMI rising to a fresh six-year high (+1.7 pts to 56.7), beating expectations of a slight decline. On a historical basis, PMIs over Q1 are consistent with a firming of GDP growth during the quarter, following 0.4 per cent qoq in Q4 2016. Improved activity data goes some way in explaining the more bullish outlook presented at the ECB’s March meeting, which pointed to “less pronounced” risks to the growth outlook, even if they “remain tilted to the downside”. ECB President Draghi also stated that “risks of deflation have largely disappeared”. Overall, with strong activity data and diminished risks of deflation, the arguments for a further taper of the Asset Purchase Programme (APP) in 2018 are strong, especially given concerns of technical buying limits and market distortions. Nevertheless, Draghi continues to emphasise there are “no signs yet of a convincing upward trend in underlying inflation”. Consequently, ultra-low rates are likely to persist.
Chinese authorities highlight “stability” as key objective for 2017; Japanese data improves, but inflation remains weak
In China this month , the National People’s Congress (NPC) highlighted “stability” as the key objective for 2017, as the government strikes a balance between economic growth and structural reforms/financial stability. Proactive fiscal policy was reiterated, as well as a prudential and neutral monetary policy. However, a subtle monetary tightening bias of late is reflected in higher (and potentially more volatile) interbank rates, stricter credit extension to the property market, and tighter regulations on financing by shadow banks given a policy focus on financial de-leveraging and containing risks. Japanese economic data has recently improved, with personal consumption and external trade gathering pace over the first months of 2017. However, inflation remains weak despite the surge in energy prices over the past 12 months. Nevertheless, at its March policy meeting, the Bank of Japan reiterated its confidence that inflation will gradually converge towards its 2 per cent target.
Emerging market assets have benefited from easing concerns over a hard-Trump trade agenda and upbeat global data
For emerging markets (EM), there has been an impressive rebound in equities year-to-date, suggesting that investors have become less concerned over a “hard-Trump” policy agenda. Investors are also responding to generally better news on the global economic cycle. Although aggregate EM equity valuations no longer look anomalously cheap, risk premia are still attractive in selective markets such as Korea, Russia, Poland and Turkey. Many EMs also benefit from undervalued currencies poised for medium-term appreciation. EM local-currency debt has not rallied as strongly as equities year-to-date, and prospective returns continue to look attractive against competing asset classes.
In terms of economic developments, Brazilian data releases improved in March, with retail sales, industrial production, PMIs and consumer confidence all rising. Positive GDP growth is expected to return in Q2-2017, whilst a slowdown in inflationary pressures could see the Central Bank of Brazil cut policy rates further in Q2. Less positively, Mexico’s data releases in March showed anaemic activity, with inflationary pressures likely to maintain a hawkish bias by the Bank of Mexico. In India, the ruling BJP’s strong performance in state assembly elections should facilitate the implementation of economic reforms, with the goods and services tax (GST) on course for a 1 July rollout. Recent data also indicates a less adverse than expected economic impact of demonetisation.
Risk asset rally implies a more targeted and cautious use of risk budgets
The macro environment remains supportive for equities, but recent price action has significantly reduced the prospective reward for bearing equity risk in an environment of high uncertainty. Equity risk premia are especially low in the US, UK and Canada. Overall we remain neutral, with a relative preference for Japan and Europe which offer higher implied risk premia. For credits, recent spread compression makes us more cautious on global high-yield credit, despite an improvement in underlying fundamentals. Amid a thinner margin-of-safety, we adopt a negative bias on our neutral stance. We remain underweight in DM government bonds, given that prospective returns still look low relative to competing asset classes. The prevailing macro environment also remains bond-unfriendly (e.g. stronger global activity, the prospect of fiscal easing). However, we still think there is a strong diversification case for owning Treasuries in a multi-asset portfolio as insurance against a deteriorating global growth picture.