Increased volatility in the first quarter has created a sense of uncertainty in equity markets but we believe that continued earnings growth and low bond yield comparatives will continue to underpin the markets. If anything, continued central government spending in the US is likely to bolster their economy and weaken the US$ at the same time, leading to stronger export activity.
This should help in a quieter way, than Trump inspired rhetoric, to at least partially address the Chinese trade imbalance. Inflation also seems to appear less intense than expected in January and this may also take pressure off proposed interest rate increases, particularly in the UK.
The UK while facing the uncertainty of Brexit could see companies with strong business franchises attract higher valuations. The converse of this is that businesses that are currently struggling, particularly if carrying high debt levels, face an uncertain future.
We may however be close to more bearish conditions in the US bond market where the 10 year Treasury bond yield has drifted up to 2.85%, almost double the UK 10 year Gilt figure. Initially the $ will take the strain, but eventually the demand for funds may leak across to the UK. This will affect corporate overseas earnings for UK companies, and this is another nudge towards domestic stocks with a solid dividend.
One area that will require close attention in this situation is our favoured sector which we call quasi bonds. Several investments have come to market, in some ways resembling corporate bonds, offering yields in and around 5%. This premium to Gilts has allowed many new funds to float, and with small discounts to the competition at launch, has helped add modest capital growth to the equation. We shall be looking more closely at fixed redemption dates and to stocks and funds with inflation protection such as the Standard Life Global Inflation Linked Bond Fund.
In summary we see opportunities in both equities and in more defensive sectors, but at times of change markets can fluctuate between trends and so care and an open mind will be required. There has been no systematic retiral of the huge sums of liquidity created to save the global banking system. While large sums have effectively plugged holes in balance sheets that have seen severe capital destruction, financial institutions have, as a generalisation, much stronger capital ratios than have been seen in many years. This wave of liquidity could swing around in spectacular fashion and we are watching trends such as rising oil prices to try and secure maximum benefit for your portfolios. A time of possible change, but not without the potential for creating added value.
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