French presidential election: Pollsters win again
So, has the reduction of political risk in Europe been sufficient to return stock market’s countenance? Well, no, but we experienced once again that what is foreseeable is already priced in, while what is truly uncertain has the ability to move markets.
The gradual downward movement of stock markets since mid-March had mostly taken place in anticipation of disappointing Q1 economic data. The week’s GDP numbers were therefore old news, whereas the French election outcome and the stronger than expected corporate profit numbers were positive surprises that signalled a better trading environment for Q2.
While it is encouraging to see improving stock markets this week and very supportive corporate earnings results, valuations remain relatively high and therefore vulnerable to any sudden change in outlook or external shock. We are optimistic that what we have observed and anticipated will carry on through the next 2 quarters, but we also remain vigilant and open to contrarian views and observations, given the ever-larger number of moving parts (economic variables with uncertain outcome) and politics which may be settling down in Europe, but continue to have potential for surprise in the US and the UK.
Trump unveils ‘biggest tax cut ever’
None of Trump’s legislative goals have been achieved and, despite the flurry of executive orders, there are increasing doubts over the viability of the fiscal stimulus package (tax cuts and infrastructure spending) which generated great fanfare at the beginning of the year. Trump himself is clearly feeling the pressure, with the tweet-happy President telling his online followers that “No matter how much I accomplish during the ridiculous standard of the first 100 days, & it has been a lot (including S.C.), media will kill!”.
Now it seems that market focus is back on the underlying economy, with the undergoing earnings season being the most intensely watched in a long time (as we discussed last week and again this week, below). There seems to be a general feeling among investors that politics will be politics, and, whether Trump manages to succeed in his fiscal plans or not, it will be the underlying economy that drives market valuations. A welcome change to be sure.
‘Risk-on’ returns as political risk fades and earnings impress
The seeming reduction in political risk in Europe and solid corporate earnings across the globe, particularly European stocks, appears to be allowing a renewed focus on resilient economic fundamentals. For Europe, the PMI (leading indicator) hit fresh seven-year highs, which suggests around 3% GDP growth for the Eurozone and corresponding double-digit Earnings Per Share growth, which would be above current analyst estimates.
We believe that European equities offer some of the most attractive upside relative to other regions at present. The combination of rising bond yields, narrower spreads, continued support from the ECB and improving economic backdrop are all strong supportive factors. In this environment, European financials – as a beta proxy – could be the main beneficiaries, along with stocks in peripheral countries like Spain and Italy, while French stocks could benefit from a centrist president.
Trading with Trump: Politics not economics
Intervention by the US Government to artificially balance trade, by means of imposing import tariffs or otherwise, may actually do more damage than good (to the US and World economies). While so-called protectionist policies may be viewed by some as a means of redressing some of the trade imbalance, it is arguably more, not less, trade that would benefit the US economy and consumer. Taxing imports, or seeking to produce every good and service it requires and consumes would significantly increase prices dramatically for consumers, while the US economy would not be able to produce nearly the same volume of goods its population currently has access to. In order to maintain the current average level of living standards, there has to be a degree of specialisation, not least where the US is not endowed with the resources needed to produce a particular good or service.
Oil market impatience for OPEC cuts to show
In the near-term, oil prices could remain under pressure, until we see stronger evidence of a clearance of existing inventory, despite robust economic growth globally fuelling higher demand. This would be particularly true if shale output in the US rises or OPEC members struggle to meet agreed targeted cuts. For now, prices and associated volatility may remain at the mercy of new reports and rumour, until supply and demand comes into balance, allowing prices to find a new equilibrium.
Click here to read the full Tatton commentary