February will be remembered for the sharp fall in equity markets across the world at the beginning of the month. Our view was at the time and remains that it was not the start of something more pronounced but simply markets letting off a bit of steam following months of rises.
"The world economy is now moving firmly into expansion phase"
Economic data during the month again suggested that the global economy continued to strengthen. Low unemployment rates are beginning to feed through to wages, which at some point will lead to higher inflation. Wage growth rates in the US, the UK, and Japan are all now higher than they were last year (Eurozone data is delayed). In the US, it was announced that the rate of growth of average hourly earnings increased to 2.9% in January from 2.7% the previous month. A similar trend is seen in the UK where wage growth rose to 2.5%.
Japan’s growth rate, though rising, is a little lower but this makes sense because there is still some slack in the labour force. One might ask why this is the case, with the unemployment rate at just 2.8%. The reason is that although Japan’s unemployment rate is low in absolute terms, it is still high in relation to historical lows. Furthermore, the female participation rate is now rising strongly, which is helping to keep overall wage pressures lower than they might otherwise have been.
Core inflation rates announced in February thus either rose (US and UK) or stayed the same (Japan and Europe). This again makes sense, given relative positioning on the business cycle. Interest rate rises have taken place in the US and the UK but not Japan and Europe, reflecting respective price pressures.
As for the emerging world, inflation rates fell in Brazil, China, India and Russia. It was particularly reassuring to see inflation fall in India, where it had risen in recent months to levels that might have been keeping the central bank awake. Consumer price inflation fell from 5.2% to 5.1% while wholesale price increase fell from 3.6% to 2.8%. It is becoming increasingly clear that inflation in the emerging world is much less of a problem than it used to be, a very welcome development.
As for financial markets, the main activity was in equity land. Having been rising for many months, and in an increasing stable manner, equity markets around the world fell sharply in the first week of February. The falls around the world were very similar, suggesting that it was automated trading systems that were to blame. In light of the fact that monetary policy was still very supportive, yield curves steep, and economic output gaps not stretched, it seemed unlikely that the declines were the start of a protracted bear market. Indeed, markets subsequently bounced back quite strongly.
On the currency front, the US dollar had a strong month. But this must be considered in the context of significant weakness over the last year. As for bond yields, performance was mixed. They rose further in the US, remained the same in the UK, and fell in Europe and Japan.
There was nothing in February’s economic data releases to cause us to question our outlook, namely that the world economy is now moving firmly into expansion phase and that we should continue to reduce our exposure to risky assets. Cash does not yet present any sort of competition for equities. Real deposit rates across the developed world are negative, presenting anyone selling equities with a challenge of what to do with the proceeds.
Published in Investment Letter, March 2018
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.
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