- Global growth remains strong, despite political and geopolitical uncertainties.
- The outlook for the eurozone is improving, supported by prospects of reforms in France, a pro-cyclical policy in Germany and a renewed European political project.
- US growth should stay on a 2–2.5% trend, and there is no recession in sight.
- Deflation is not a threat for next year, as inflation is expected to stabilise at around 2% in developed countries, after temporarily slowing in Q2.
- A new monetary regime will dominate in the coming years, as central banks progressively put an end to their ultra-accommodative strategies.
- Our asset allocation continues to favour equities. Sustained global earnings growth should support equities in the second half of the year but elevated valuations suggest that returns will probably be more modest than in the first half.
- Given the particularly high valuations in the US, we prefer non-US equities in Europe, Japan, and Asian emerging markets. Technology and banking are our preferred sectors.
- Global bonds should adjust to the tighter monetary regime and the end of cheap money. Floating-rate notes and non-directional bond strategies should benefit from rising interest rates and an increase in the volatility of the bond markets.
- With expensive valuations in both equities and bonds, increasing performance dispersion between regions and sectors should allow hedge fund strategies to bring diversification benefits to portfolios.
Positive outlook despite political risks
The first half of 2017 was unusual in many ways. On the political front, after years of uncertainty, stability prevailed in continental Europe, as centrists pushed back the rising tide of populism in the Netherlands, Austria and, most recently, France. In contrast, the world cringed as the leading political power since the end of the Cold War stepped down from the global stage under its new president, Donald Trump, and instead engaged in domestic wrangling.
Though the second half of the year promises its share of political events – including the national party congress in China, German federal elections, potential Italian elections, the kick-off of Brexit negotiations, and the start of campaigning in the United States for the 2018 Congressional elections – just as in the first half, we expect economics and earnings to be the key drivers for markets.
Despite lingering political and geopolitical risks, the outlook remains positive and world growth should hold up, coming in at close to 3.6% in both 2017 and 2018. Although oil price volatility has surged recently, prospects in the main regions are still encouraging, with growth likely to rebound to 2% in developed countries and to near 5% in aggregate terms across emerging countries.
Prospect of a new deal for the eurozone
Though European growth data has been persistently surprising, the election of Emmanuel Macron has the potential, both in France and the broader eurozone, to step up the pace of activity and reform. His programme is based on liberal and pro-European reforms. If implemented, it should give a much-needed jolt to the French economy, whose growth has remained stuck on a 1% trend since the financial crisis, and it could also demonstrate to Europe that a French government is capable of far-reaching change.
One major step will be the reform of the labour market, due next September, which should give the economy more flexibility and open the door to other significant measures. But some of those (such as a corporate tax cut and a revision of labour costs) face a major fiscal constraint, as France’s budget deficit to GDP is above 3%, which means they will probably have to be delayed until next year so that France can bring that deficit back below the 3% target and be credible among other EU governments. Macron obviously has an ambitious programme for the eurozone (a joint budget, an investment plan and a new political project), which has been welcomed by Angela Merkel, who has signalled that Germany will be open to discussions after its September elections.
The German chancellor has reform plans of her own: her electoral programme focuses on significant tax cuts for families (up to EUR 30 billion) and public spending is already increasing, in a departure from the widely criticised fiscal austerity of recent years.
The combination of French reforms and increased German spending gives the European political project a new lease of life and could lift the eurozone’s economic growth to a higher medium-term trajectory (2–2.5%), closer to the US trend, making the region less dependent on the rest of the world. If European integration is taken yet further, the prospect of a federal budget (on some specific items initially) would rebalance the policy mix and reduce the influence of central bank action.
In the UK, both the economic and the political outlook have darkened. After the snap elections in June, the loss of the Conservatives’ majority in parliament has weakened prime minister Theresa May, who has been forced to strike a confidence-and-supply deal with the Democratic Unionist Party. Meanwhile, domestic economic activity is flagging and there is no immediate prospect of renewed budgetary or monetary stimuli. As Brexit negotiations kick off, the EU has the upper hand and has been able to impose its own agenda. This will make it difficult for Theresa May to strike separate new trade deals in parallel with the Brexit talks, as originally planned. Added to this, the debate on a soft-versus-hard Brexit has come back to the fore, generating more volatility and uncertainty around sterling.
In the US, though it appears increasingly unlikely that the Trump administration will be able to successfully pass new tax legislation in 2017, a recovery from the seasonally slow first quarter should keep the US growth rate in the 2–2.5% range for the rest of the year. Fundamentals remain strong for consumers and sentiment is still positive even though none of the promised tax cuts have materialised: the economy is close to full employment and wages could grow more than expected in the next quarters (due to mounting signs of a labour shortage), house prices are still rising faster than inflation, and wealth effects are supporting consumers. Besides volatility in the manufacturing sector and fiscal uncertainty that could potentially impact investment, consumption should continue to drive US growth.
Michaël Lok
Group CIO and Co-CEO Asset Management
Norman Villamin
CIO Private Banking
Patrice Gautry
Chief Economist