An Encouraging Start
Unlike in recent years, the beginning of 2017 was not marked by a great deal of market volatility, but rather a continuation of the impressive climb we saw in equities late last year. Undoubtedly, the arrival of a new administration in Washington certainly played a part, as investor sentiment remained buoyed by the prospect of tax and regulatory reforms, as well as increased infrastructure spending. Though this agenda is certainly encouraging in many ways, as the quarter progressed it became clear that it may take some time, and a good deal of compromise, for it to come to fruition. As such, it may be too early to count it as a major tailwind for the U.S. economy going forward, regardless of what equity markets may indicate.
With that being said, there was a fair amount of economic data this quarter to encourage investors. In the U.S., employment numbers remained strong, and wages have continued to rise. These sustained improvements led the Federal Reserve to raise interest rates by another 0.25% at its March meeting. However, in the press conference following this announcement, Fed Chair Janet Yellen clearly pointed out that this decision was based upon progress towards the central bank’s goals of achieving stable prices and maximum stable employment, and not upon any revised views on the growth outlook going forward. Though the Fed did admit it saw a possibility for higher inflation in the near future, it generally expects the pace of growth in the U.S. to remain moderate. Nevertheless, markets continue to price in another two more rate hikes over the course of the year.
Such moves may be justified, especially given evidence the outlook for global growth may finally be improving. In the Eurozone, it appears that the ECB may well have successfully overcome the specter of deflation through its unprecedented stimulus measures. Though statements by Mario Draghi in March signaled that its large-scale bond-buying program would remain in place for the balance of the year, upward revisions in the central bank’s growth and inflation forecasts have led some to speculate that monetary policy in the Eurozone may tighten more quickly than previously expected. Meanwhile, better than expected data coming out of China seemed to, at least for the time being, alleviate fears of a slowdown in the world’s second largest economy. As such, emerging markets moved significantly higher this quarter, further bolstered by the absence of any major changes in US trade policy.
Threats to Growth
With all of this considered, it is safe to say we appear to be in slightly more optimistic times, especially in comparison to a few years ago. There is data to suggest that we are seeing the beginnings of a potential synchronized global economic expansion, which we have not seen since the end of the financial crisis. With that being said, we do feel it important to highlight a number of risks that stand to stunt these green shoots in global growth, however encouraging they may be.
Geopolitical concerns have certainly caused worries as of late, and though their impact on markets so far has not been substantial, this could easily change should certain situations deteriorate. In particular, North Korea’s recent provocations could lead to further tensions in East Asia, especially as the U.S. has taken a more hardline stance to the reclusive dictatorship recently. Concurrently in the Middle East, the situation in Syria has changed significantly as the U.S. has clearly increased its involvement in the region. Though the U.S. has engaged in attacks on the Islamic State in the past, increased use of military force, including a recent strike specifically targeting the Assad regime suggest a major change in U.S. policy towards Syria. Given Russia’s strong support of Bashar Al-Assad, fears are the U.S. and Russia could find themselves directly fighting on opposite sides of this conflict. With U.S.-Russian relations already strained at best, we worry that divisions over Syria could lead to increased estrangement between the two countries.
Meanwhile, though Europe has seen improving economic fundamentals, uncertainty continues with the rising tide of populism across the continent. Though victory by a mainstream party in the Dutch elections in March assuaged some of these fears, attention has since turned to the upcoming vote in France this month. While anti-EU candidate Marine Le Pen is not expected to be the ultimate victor in France’s multi-round elections, this has not kept European markets from pricing in the prospect of a surprise outcome. Cohesion within the European Union has certainly been shaky as of late, and many of us were reminded of this when the UK formally began its process of departure from the EU in March. Since then, Prime Minister Theresa May has called for early elections in the hopes that she can garner stronger political support leading up to what are sure to be difficult negotiations with Brussels over the UK’s future relationship with the EU. While this may take a degree of Brexit-related uncertainty off the table, we feel that as this process progresses we may see new challenges arise, especially if there are major changes in leadership any of the major EU member states this year.
Looking Ahead
In our eyes, calling attention to such risks is not important merely for its own sake, but also given the somewhat precarious nature we find the markets to be in. Should the global economy indeed be at the start of a renewed growth trajectory, the recent run up in equities and other risk assets could be quite justified. However, should we come to find more surprise to the downside, we believe that current valuations all too often provide little to no margin of safety. As such, despite our best efforts, we continue to see very few compelling new investment opportunities at present. However, such “quiet” periods are not without their own advantages, and much of our time recently has been spent not only considering the risk positioning of portfolios, but also developing a plan for how best to put capital to work when opportunity returns to the markets. While risk management can take many forms, we feel patience plays important part in our process, especially in an environment like this one.
As always, we welcome your thoughts, and greatly appreciate your support and trust.
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