Reasons for Optimism
Yet again, we saw equity markets continue to rise amidst an improvement in the outlook for global growth. The U.S. economy has continued to show signs of further strength, and now Europe seems to be beginning to follow suit. Such improved sentiments have helped bolster many emerging markets, even as many central banks begin the path to tightening monetary policy. While we find all of this to be quite encouraging, we do see a number of risks worth considering as we move forward.
Economic data in the U.S. was generally solid this quarter, as continued strength in employment and consumer confidence numbers came without the uptick in inflation many have been expecting for some time now. However, the overall outlook remained constructive enough for the Federal Reserve, which again raised interest rates by another 25 basis points in June. In addition, the Fed outlined its initial plans to begin unwinding its $4.5 trillion balance sheet later this year, provided the economy remains on its current trajectory. This announcement comes nearly a decade after the central bank began large-scale purchases of assets amidst the financial crisis, and represents yet another step towards monetary policy normalization in the U.S.
Over the past few months, concerns have been raised over whether the Trump Administration can deliver on many of its outlined policies. The dismissal of FBI director James Comey in May certainly amplified these doubts, especially as they relate to a probe into foreign interference in the 2016 presidential election. Most news, especially over the course of this quarter, was focused more on these issues than on policy implementation. Consequently, the momentum of the reflationary “Trump trade” seemed to wane a bit, as the consensus shifted on what the “base case” for the administration’s policies may mean for the economy. There are a wide variety of opinions on what policies could merely be delayed and which could be ultimately derailed, whether we are considering the new healthcare bill, tax reforms or any major fiscal spending package. Overall, given the level of uncertainty here, we feel making any bet, positive or negative, based merely upon what could happen in Washington, is a fool’s errand at best.
However, this uncertainty did little to weigh on equity markets abroad, which generally benefited from an improving picture of global growth. In Europe, after many false starts, many seem to be definitively recognizing the economic recovery occurring. This was corroborated by encouraging economic data coming out of the Continent, as well as constructive statements by ECB President Mario Draghi. In addition, fears over a further disintegration within the Eurozone continued to dissipate, especially following Emmanuel Macron’s victory in the French presidential elections in May. Though fears of a subsequent tightening in monetary policy weighed on markets somewhat, European equities nevertheless performed quite well over the quarter, given what appear to be generally improving fundamentals in the region.
Investors also remained positive on emerging markets, which continued to rise in the quarter. Continued signs of improvement in the Chinese economy certainly helped, as did a weaker US dollar. Nevertheless, there were exceptions, as crude oil prices weighed on Russia, political scandal caused declines in Brazilian markets, and the diplomatic spat between Qatar and several of its neighbors created uncertainty in the Middle East. However, in spite of these more localized issues, continued improvements in the outlook for global growth, especially with Europe factored into the equation, created a supportive backdrop for emerging market assets.
Lessons from the Past
As we have discussed in the past, the notion of a global economic expansion seems more realistic to us now than it has in recent years. Worries over a slowing Chinese economy have abated, Europe finally seems to be emerging from the doldrums and the data coming out of the U.S. generally appears to be solid. However, just as we finally reach this seemingly ideal scenario, we must again consider the risks that may well be on the horizon.
Time and again, we have seen this current period likened to the late 1990s: an environment of low inflation and U.S.-driven growth, which has bolstered equity markets around the world. This comparison, in many ways is a good one, given that that bull market, much like this one, had plenty of detractors, many of whom were ringing the alarm bells somewhat early on. Though the term “irrational exuberance” is so much associated with this period, many forget that Fed Chair Greenspan uttered that phrase in 1996, quite some time before that cycle ended. While we have heard some posit that we are at a similar point in the timeline this time around, with ample room left to run, there are several reasons to be skeptical.
Though equity markets are nowhere near as frothy as they were during the height of the “tech bubble”, the lack of compelling opportunities in the market utilizing our valuation methodology suggests to us that valuations are at the very least full, if not stretched. The environment in private markets appears similar, with several deals we have reviewed recently leaving us unconvinced at best. While there is plenty to be excited about, we think that this environment is more fragile than it appears. Any number of risks we’ve discussed recently, be it political gridlock in the U.S., a downward shift in the Chinese economy, or a disruptive geopolitical event, could easily derail this state of affairs. Even absent such events, the market’s reaction to recent, more speculative IPO issuances suggests investor sentiment may already be turning somewhat.
As such, we increasingly believe it may now be prudent to take an even more defensive positioning in portfolios. Much of our time has been spent identifying exposures that could stand to be trimmed, not only for the sake of risk management, but also to provide us with dry powder should a change in the environment present new opportunities. With that being said, we can certainly be flexible here given your individual risk appetite and needs, and thus encourage you to reach out to us to discuss your concerns about such portfolio changes. We look forward to hearing your views, and working with you to come up with a solution you feel most appropriate in these times.
As always, we welcome any thoughts and feedback you may have, and greatly appreciate your support and trust.