Global Indices in February
Global markets were relatively flat with investors still undecided on whether to embrace growth in major markets or worry about state impact. Political uncertainty has marred the potential boost from positive global corporate earnings.
*Equity Indices - FTSE Global Indices in CAD, Bonds - Barclays Global Aggregate Canadian Float Adjusted Board Index
In February, the US and developed markets saw higher earnings performance, while flat commodities prices kept Canadian and other resource-dependent economies at bay. Where equities lacked expected volatility, bonds picked up the slack (see chart below), torn between comments of Fed Chairman Yellen’s calls for hikes and President Trump’s threats against them. We’ll look at the two sides of the coin that are keeping investors on their toes.
Source: Bank of Canada
Positive Global Corporate Earnings
US corporate earnings have been positive for a while now. As of late, the US market has been lifted by more expectations of corporate tax cuts and deregulation. But the more promising trend is that several other major economies are turning the corner. Pre-tax quarterly profits are at the highest level they’ve been in 10 years, Asian trade has risen, and European earnings are on course for their best quarterly returns in 6 years. The chart below highlights this trend in estimated earnings growth.
Source: BlackRock Investment Institute, MSCI and Thomson Reuters, February 2017.
Notes: The lines show the three-month change in the aggregate 12-month forward earnings estimates. The data are based on MSCI U.S., Europe, Japan and Emerging Markets indexes.
We can attribute this growth to increasing consumer spending, persistent and favourable monetary policy, and open trade. If these conditions stay in place, or perhaps even improve, it will bode well for the global economy. But the question is how likely are these favourable conditions to remain?
On February 28th, President Trump made a highly-anticipated address to the nation where investors hoped to finally get some clarity on tax reform and the upcoming budget. As has been the case with this president, details were left out causing ambiguity over what to expect. On tax reform, for example, Trump said that “historic tax reform will reduce the tax rate on our companies.” No indication of how or when that will take place, so a change which has created so much fervor has yet to materialize as an possibility. Coupling this ambiguity with the protectionist rhetoric, the range of potential outcomes from these uncertainties threatens the stability of global trade and upward growth. However, markets have taken the upbeat tone of his speech with optimism and reacted positively.
Donald Trump isn’t the only politician winning favour for the protectionist core. Marine Le Pen, running for French president, proposes to redenominate French debt in francs and is a proponent of leaving the EU. This trend is popping up across Europe and it threatens to destabilize one of the main drivers of growth - open trade.
Source: World Trade Organization
The threat of policy uncertainty alone has slowed global growth by as much as 0.6%. According to a report from the World Bank “Policy uncertainty in Europe and the United States had a negative impact on trade by reducing overall global growth. In a more uncertain environment, firms may choose to postpone investment and export decisions and consumers may cut back spending. The threat of unraveling trade agreements may also hurt trade growth by adding to policy uncertainty.” Until there is more clarity from state heads, the risk of trade wars will keep investors wavering.
For long term investors, it’s important to stick the course and expect volatility. If I sound like a broken record, that’s because it’s the strategy that makes the most sense. Despite the recent highs in markets across the globe, there is still an enormous amount of cash on the sidelines. That uncertainty is keeping a lid on potential growth. While there is a possibility of unfavourable political changes, the overwhelming force of common growth is an enduring undertone.