Milford & Dormor Financial Planning held its quarterly Investment Committee Meeting on Friday 31/08/2018. Matthew Clark, Director and Chartered Financial Planner, led the conversation about the current economic environment, investor sentiment and political climate, and how these are likely to affect our investment propositions.

Our current view is that despite the recent political turmoil, the underlying picture is overall fundamentally still positive. We do not expect the current bull market to end in the next quarter and are therefore making only moderate changes to our investment models to better position them for the upcoming volatility.

And volatile the markets are expected to be. The political noise created by Brexit as well as Trump’s trade wars make the markets very unpredictable, and as we know, the markets do not like uncertainty.

Looking into the global markets as a whole, the main developments we’ll be keeping an eye on in quarter 3 are the US interest rate policy, China’s response to a slowing economy and Italy’s forthcoming budget negotiations, as well as the turbulent emerging markets.

If the US Federal Reserve (the central bank of the US) increases the interest rate that would mean a more expensive dollar as the cost of borrowing increases, and that in turn would have a considerable negative effect on emerging market economies. After the end of the global financial crisis, record low interest rates in the US meant many developing nations borrowed in dollars and as the dollar rises, those developing countries have to pay a lot more to repay their debts.

The ongoing US – China trade war is partly to blame as investor confidence in China has taken a significant hit. Its economy is showing signs of weakness as a weakening yuan and a slump in stocks cost the country its rank as the world’s second-biggest equity market. Earlier this month, data showed industrial profits slowed for a third straight month to 16.2 percent year-on-year growth in July, according to Reuters. Other reports for last month showed fixed asset investment grew at its slowest pace since the 1990s, while retail sales slowed and missed expectations, according to Reuters.

The outcome of the Italian budget negotiations will also have a significant effect on investor sentiment towards Europe. Turbulent Italian politics sent tremors through global markets earlier this year. Investors have been hammering European stocks and bonds ever since, betting more trouble lies ahead. Investors fear Italy’s government could announce a budget this autumn that puts the country’s debt on an unsustainable course and so amplify tensions with Brussels. But if the budget is passed smoothly, investors may start looking at European equities again.

The UK equity market has also suffered. Uncertainty surrounding Brexit negotiations and the increasing prospect of the UK leaving the EU without a deal have had their negative effect on investor sentiment. UK equity funds experienced monthly net retail outflows of £532m, making London’s market the least popular among private clients and their advisers. In line with those expectations we are reducing our UK exposure in favour of the US.

And the US is still going strong. The longest ever bull run has lifted US stock and provided a strong source of growth. US companies are posting enviable earnings and are supported by solid economic data while China, Europe and many emerging market countries are all struggling. But nothing goes on forever and even the most passionate US-focused investors are recognising the fact that the bull run will at some stage come to an end. Central banks are turning off the tap on post-crisis stimulus and the yield curve is flattening. The 10-year yield is stubbornly stuck below 3%, a sign that the markets expect only modest future US economic growth and insignificant rise in inflation. The flattening of the yield curve is bringing the 2-year and 10-year bond yields very close and is a characteristic of a late-cycle economy which appears at odds with the rosy picture painted by robust US economic data and corporate profits. The US equity market is also highlighting potential for trouble in paradise. The demand for US stocks has focused on a small number of fast-growing companies who are less reliant on the economic cycle, a signal that the markets are due to cool off.

Although the above warning signs are in place to tread carefully, underlying data is still positive. S&P 500 has bounced back from its spring losses and is approaching record breaking highs. The strong economic growth, exceptional corporate profits, tax cuts and extensive share buybacks all helped propel US GDP to 4.1% in the second quarter. The vast majority of companies comprising S&P 500 also posted better than expected earnings, with overall US corporate earnings rising by 24.8% in Q1 and 24.6% in Q2.

The exceptional US economic growth has been driven largely by a small group of technology giants – the so called FAANG, namely Facebook, Amazon, Apple, Netflix and Google (Alphabet) – who have seen soaring profits and growth rates over the past few years. But warning signs have recently appeared there too. Facebook posted a profit warning in light of lower than expected user and advertising growth which sent its shares tumbling down. Intel, Netflix and Twitter also disappointed investors making them reconsider future growth prospects.

However, considering just how strong technology companies’ corporate earnings have been, these are perceived as temporary blips. We believe that the US still has some way to go and do not believe any major corrections will occur in the short term. We do however recognise all the warnings signs highlighted in this article, therefore we are moving our investment focus away from the big technology giants and towards smaller US companies.

Please note, our Market Overview & Outlook is our view of markets and does not constitute investment advice. Past performance is not necessarily an indication of future returns; the value of investments and any income from them is not guaranteed and can fall as well as rise. Overseas investments are affected by currency movements and exchange rates. If you would like investment advice on your individual circumstances, please do not hesitate to get in touch.