Despite a promising start to the New Year, we experienced a market sell off late January but most equity and bond indices are not far away from where they were at the start of the year. However, this has meant that it has been a challenging environment in which to generate decent returns in a balanced portfolio.
Four key forces have been pressuring stocks.
While first-quarter earnings were generally strong, many major economies, including the US, the Eurozone and Japan experienced a deceleration in growth in the first quarter. While this was largely seasonal, and for some economies may be attributed to poor weather conditions, the first-quarter slowdown appears to have fed into at least the start of the second quarter for most of these economies.
In addition to lower growth, we saw pressure on input costs, which cause a narrowing of profit margins. For example, oil prices helped to push up input cost inflation in the Eurozone, which is at its second-highest level in seven years. It is also fair to expect upcoming US employment situation reports to show that wage growth is rising. Rising costs cause a narrowing of profit margins, all else being equal, which in turn reduces earnings.
Monetary policy concerns.
A concern is that very accommodative monetary policy might soon end. The Fed’s policy-making arm (the Federal Open Market Committee) increased its median policy prescription for the federal funds rate, and the European Central Bank (ECB) announced it would end tapering by December. We also saw jitters earlier this year when markets began to fear that the Bank of Japan (BOJ) would begin normalization sooner than expected — although the BOJ quickly refuted that concern.
We have seen a lot of geopolitical uncertainty in recent months. We have seen the difficulty that Germany had in forming a coalition government, the strained relationship between the different political parties in that coalition as well as the difficulty the UK has had in orchestrating its Brexit from the European Union. In addition, we have seen fluctuating tensions between the US and North Korea. These were just a few of the geopolitical risks adding to the volatility we have experienced this year. The most recent example is the potential for Italy’s coalition government to disrupt not only Italy, but also the European Union.
Outlook for the second half of the year.
It may be a continued game of Snakes and Ladders as we move into the second half of the year. The global economy should accelerate modestly from here. The US is already showing signs of re-acceleration. In addition, with respect to the Eurozone, it is believed that there are still positive drivers of this region’s economic growth in 2018.
The International Monetary Fund (IMF) expects the global economy to grow at 3.9% for both 2018 and 2019.
However, debt pressures are expected to grow. The world is becoming increasingly indebted. As borrowing costs rise, debt is becoming a bigger issue for consumers, businesses and the government. If monetary policy normalization continues and accelerates in coming years, this pressure is likely to increase. In addition to the short-term effects of debt pressure, there is a long-term effect as well: more money spent on servicing debt means less money available for investment purposes, and that will affect longer-term economic growth.
Protectionism may continue in the second half of the year, which may make the markets nervous. In addition, the current tariff rhetoric and actions are increasing economic policy uncertainty, which has historically coincided with a slowdown in business investment and this could threaten the upward bias for stocks that currently exists.
Sue Stevens, Director at Dentons Wealth commented on what this might mean for investors
“I believe exposure to risk assets is important for meeting long-term goals especially as I believe that there is an upward bias for stocks, albeit in a weaker form. However, mitigating downside risk will be critical, in my view, we have addressed that by well-diversified risk based portfolios which are reviewed monthly taking into the considerations of our Investment Consultancy firm, Rayner Spencer Mills.”