Market View October 2017: what’s affecting global markets?

Andrew Milligan

Almost a year on from Donald Trump’s presidential election victory, I reflect on how his term has affected the economy and markets so far and what might lie ahead. I also take a look at how markets are responding to growing political tensions, what Angela Merkel’s re-election means for Europe and the UK, and what a rise in UK interest rates could mean for consumers.

Trump’s term so far

The first thing to note is that the US stock market is up over 12% from this time last year, at the time of writing. This is partly due to the economic strength of the US and the wider global economy. For example, the US is benefitting from strong export growth to Asian and European countries. But it also reflects both what President Trump has done and what he hasn’t.

The Republicans recently announced a blueprint for a large tax-cutting package which could have clear positive effects on some US firms (although whether they can get this through Congress is still uncertain). Other businesses, including healthcare, financial and coal companies, are also benefitting from easier regulation under the Trump Administration.

But overall when it comes to the Trump presidency so far, the expression ‘the dog that didn’t bark’ springs to mind. Despite a lot of bluster during his election campaign about protecting US trade, President Trump has erred on the side of caution, particularly in relation to China. He has also moved more slowly than expected over the renegotiation of the North Atlantic Free Trade Agreement (NAFTA).

Of course, other aspects of his policy-making, such as the tensions with North Korea and the turnover of staff in the White House, continue to concern markets. This may be part of the reason why the US dollar hasn’t been one of the more favoured currencies in 2017.

US stock market is up over 12% from this time last year, at the time of writing

Growing political tensions

Despite growing political tensions, on the whole markets are doing quite well, although individual markets are often affected by specific events, such as the recent Catalan independence vote. As I previously mentioned, the US stock market is up over 12% from this time last year, with Asia and Europe seeing returns closer to 20%.

Many economists have raised their 2017 global growth forecasts, and that’s before the effects of any major tax-cutting package in the US are known. Understandably though, the situation on the Korean peninsula needs to be very carefully monitored.

At Standard Life Investments, we still believe that conflict will be avoided because of the very high costs for all parties. That said, the risk that something may happen has definitely risen.

UK interest rates to rise

A rise in UK interest rates in November is now very likely. Financial markets have already priced this news into the pound, gilts (government bonds) and equities, and a series of Bank of England speeches have made it clear why they’re considering taking this action. The reasons include: a global withdrawal of quantitative easing (QE), the threat of rising inflation and their opinion that the economy will be able to cope.

Of course an interest rate rise could though have a negative effect on consumer sentiment. For many home owners, this will be the first change in interest rates since they took out their mortgage. The Bank of England has also warned about the risks from high levels of unsecured loans.

Guidance from the Bank of England will play a key role in how markets react further down the line. Does it expect any or many interest rate rises in 2018? The other issue is how easily households can afford higher borrowing costs.

Brexit negotiations – more certainty at last

Recent talks about a transitional agreement which could last several years have provided more certainty for many UK and overseas businesses. This was one reason, alongside hints about interest rate rises by the Bank of England, that explains a sharp jump in the pound against the dollar and euro. On the other hand, a stronger currency is a negative for the FTSE® 100 Index, which includes many companies that operate outside the UK. That’s one of the reasons why the UK stock market has underperformed many of its competitors recently.

The European economy looks strong going into 2018

Merkel’s re-election, Europe and the UK

Headlines have concentrated on the far right and far left parties gaining a sizeable representation in the German parliament. However, their ability to affect policy-making will still be quite limited.

It looks like Mrs Merkel can form a workable coalition involving the Greens and the Free Democratic Party (FDP), together with her Christian Democratic Union (CDU) party and the Christian Social Union (CSU). But the coalition may not be a smooth one. There are some noticeable differences on matters such as energy policy, taxation and European integration, and it’s likely to take some time to reach an agreement that satisfies all three partners.

It’s worth noting though that the implications of the coalition may be more important for the rest of the European Union (EU) than domestic German policy. For example, the FDP has been quite clear about enforcing EU monetary and taxation rules through sanctions and a two-speed eurozone – the idea that different parts of the EU should integrate at different levels and pace depending on their political situation. This is the opposite to the recently expressed views of French president, Emmanuel Macron. And, as far as Brexit is concerned, the time it will take to form a workable coalition will limit Mrs Merkel’s involvement in negotiations.

The outlook for Europe remains strong

The European economy looks strong going into 2018. This strong economic outlook has allowed the European Central Bank (ECB) to start cutting down its bond buying programme (QE), and is even considering raising interest rates. Germany, France and Spain lead the way, and even Italy is seeing stronger growth.

This reflects a positive cycle of lower unemployment, better consumption and more trade. There’s also been a lot of good news priced into European stock markets, leading to around a 20% rise in euro terms. This is down to a wave of money leaving the US this year and investing in Europe instead.

If the value of the euro begins to fall against the US dollar that might provide more support for exporters in Europe. Financial companies in Europe would also benefit from higher interest rates. As such, Europe remains one of our favoured equity markets globally as we believe company profits can remain solid into next year.

If you have any questions about your investments, as always we recommend you speak to your financial adviser.

The information in this blog should not be regarded as financial advice. Please remember that the value of your investment can go up down as well as up and may be worth less than you paid in. Information is based on our understanding in October 2017.