Danske Invest’s chief analyst Jan Holst Hansen expects global growth to continue and has increased the weighting of European equities. He explains why in this blog.
January’s economic data again pointed to a growing global economy, while politics once more played an important role – both in terms of central banks and policymakers. The new US president, Donald Trump, naturally grabbed much of the attention.
Following his election victory, the financial markets were initially buoyed by considerable optimism on a series of initiatives the new president had announced. As January progressed, however, concerns about Trump grew and investor optimism began to fade.
Nevertheless, our overall view is still that the global economy will continue to grow at a robust pace and that the expansion will be primarily fuelled by growth in the manufacturing sector. We estimate that European equity markets in particular will benefit from this, and have therefore increased the share of European equities in our portfolio solutions, where we put together portfolios on behalf of our customers.
In contrast, we view corporate bonds as having jumped the gun. We estimate that corporate bond yields in both the US and Europe have now dipped so low that they do not sufficiently take into account the risk of bankruptcy. For this reason we have decided to reduce our weighting in corporate bonds and are now underweight in both regions.
Overall, this means we now have a significant overweight of equities in our portfolios relative to our expected long-term level.
US: Will Trump disappoint?
US business confidence continues to demonstrate considerable strength. While companies reduced inventories throughout 2015 and 2016, this trend has reversed, which means corporate inventory building is again contributing positively to growth. The labour market remains strong. Unemployment rates have remained low and we expect wages will continue to grow. The US central bank, the Fed, will thus be under pressure to normalise monetary policy from the current low level of interest rates.
Since the presidential election the financial markets have been very much focused on what exactly Donald Trump would implement – not least in terms of taxes and trade. Now that Trump has finally been inaugurated as president, we have a little more clarity. A comprehensive tax package now seems less realistic, for example. During his campaign Trump stated he would finance tax cuts through measures such as tougher taxes on imports and less tax on exports. The prospects for this happening are not good, however, and that leaves less money to finance a comprehensive tax package. Hence, in our view the financial markets have potentially set their sights on greater tax cuts than Trump will be capable of delivering.
In terms of trade policy, he has already delivered on his promises. For example, he pulled the US out of the Trans Pacific Partnership (TPP) free-trade negotiations on his first working day in the White House. He has also indicated he will pursue a tougher line in his dealings with Mexico – just as he warned during the campaign. With respect to this tighter trade policy, we would underline that it is still most probably the Asian nations that could get hit.
EUROPE: Accommodative ECB despite rising inflation
We saw further signs in January that inflation is beginning to rise in Europe. German inflation in particular has risen significantly of late, which has created concern that the European Central Bank (ECB) will begin to tighten monetary policy. We have previously seen the ECB hike interest rates when inflation was driven higher by increasing oil prices – for example, in 2008 and 2011.
This time, though, we are convinced the ECB will ignore the increase in oil prices – not least because central bank chief Mario Draghi said at a press conference earlier this month that we should place less emphasis on the effects of exchange rates and oil, etc., and instead focus more on underlying inflation to understand the ECB’s monetary policy. This is why we expect the ECB will maintain its accommodative monetary policy stance for some time yet.
January also saw a string of other positive numbers that indicate the economy is still growing decently. As in the US, a stronger manufacturing sector is also the main driving force in Europe.
CHINA: House prices and growth stabilising
China is also benefiting from a stronger manufacturing sector, just like the US and Europe. The Chinese authorities have now got to grips with price inflation, which in 2016 led to overheated housing markets in the major cities and increased financial risk generally. The government intervened by, for example, tightening credit and enacting measures to curb speculation in the housing market. These measures have now resulted in declining house price inflation, with the December inflation numbers (published in January) showing house price rises of close to zero This compares with price rises of 20-30% in early autumn 2016.
Investment in the property market remained reasonable in January, but we estimate the intervention in the housing market will also hit the construction sector and lead to a slowdown in activity here in 2017. Nevertheless, we expect overall Chinese growth to remain flat at around 7%, as the negative fallout from a cooling housing market will be balanced by the positive impact of a strong manufacturing sector.