Questions we're tracking

Each month we will answer five of the top questions on investors' minds and on our minds as we determine our House View positioning.

What are the real risks to the business cycle?

In the age of 24/7 news, there is rarely a shortage of concerning headlines. But investors would do well to ignore most of the "noise"—even if it temporarily moves markets—and focus on monitoring genuine risks to the business cycle. We believe the Middle East, North Korea, and Italy pose only remote threats to the cycle and the risks of faster Federal Reserve tightening and rising protectionism are more genuine threats.

Did you know?

On 29 May, the yield on two-year Italian government bonds surged by 184bps, the largest one-day move for a two-year G7 bond since 1982, when US Treasuries jumped 146bps.

Italy's new Finance Minister Giovanni Tria said in an interview that “the government position is clear and unanimous. There is no discussion about leaving the euro.”

Will US protectionism spark a trade war?

US protectionism has raised concerns that simmering tensions could boil over to a full-scale trade war. Most recently, the US implemented tariffs on USD 34bn worth of Chinese imports, with China immediately responding in kind on US imports. Elsewhere, the news was more positive, with the EU reportedly considering a multilateral deal to eliminate most tariffs on autos to avoid a trade war with the US. Recent escalation doesn't create optimism for a near-term breakthrough. We continue to advocate a negotiated solution, but are monitoring growing trade risks.

Did you know?

NAFTA is the most important trade issue in terms of direct impact upon the US economy. US exports to China totaled about USD 32bn in the first quarter of 2018, vs. USD 137bn of US exports to Canada and Mexico.

Among Chinese listed stocks, international sales make up a low-teens percentage of total sales, of which the US accounts for around 20%. This implies that their direct sales exposure to the US is around 3%.

Should high oil prices worry investors?

After hitting USD 80/bbl in late May, oil prices came under pressure in anticipation of a production increase from OPEC and its allies (OPEC+). But the decision to increase supply is unlikely to fully offset falling Venezuelan and Iranian oil supply, and bottlenecks in oil infrastructure might slow US crude production growth in 2H18. Overall, the oil market remains in deficit; we remain positive on the six-month price outlook but believe global markets can withstand high oil prices.

Did you know?

We estimate that a spike to USD 100/bbl would shave only about 16 basis points (bps) off global GDP growth next year, with oil producers adding 5bps to growth and consumers subtracting 21bps.

The resumption of US sanctions could reduce Iranian oil exports by 250,000–500,000 barrels a day—from a recent average of 2– 2.5mbpd—according to consultant FGE.

Is a strong dollar here to stay?

After a 20% fall against the euro between the start of 2017 through February 2018, the US dollar has been making a comeback. The DXY Index hit its highest level of 2018 on 28 June, and the USD is now up 6.7% against the EUR since its February low. The rise in US government bond yields—combined with a soft patch in economic data outside the US—means dollar strength may persist in the near term. Even so, economic and market fundamentals suggest we are still in a long-term USD bear market.

Did you know?

Because of persistent current account deficits, US external debt is rising rapidly (as seen from the growing deficit in the net international investment position). At more than 40% of GDP, US net liabilities are at a record level.

A large part of the increase comes from the powerful gains for US equities and USD strength since 2013.

Should investors give up on emerging markets?

Emerging markets are under pressure. The JPM EM Currency Index is down nearly 10% since mid-February, with the Turkish lira and Argentine peso hitting fresh lows. EM equities have also fallen around 15% from their all-time high in January. But the long-term outlook for emerging markets remains positive. We expect GDP growth to rise from 5.2% in 2017 to 5.4% in 2018 and inflation remains relatively subdued, meaning that growth-harming rate rises can be avoided in many cases. Profit growth remains solid, with MSCI EM earnings per share set to rise 8–12% this year, and valuations look attractive vs. developed markets. But as long as the US dollar and US government bond yields are rising, emerging markets may face headwinds in the short term.

Did you know?

The MSCI EM Index is trading at 13.3x 12-month-trailing P/E, vs. 17.5x for developed markets, a 23% discount (deeper than the 10-year average discount of 18%).

EM equities (excluding A-shares) have attracted inflows of more than USD 26bn since the start of the year, according to Morgan Stanley. Recent volatility has seen this slow but not reverse.

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