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Market Insights – March 19th, 2018

Weekly financial & economic analysis.

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Essentials

The European Union has adopted a firm tone in response to Donald Trump’s decision to apply import tariffs. The EU is planning to introduce its own tariffs on products such as Harley-Davidsons, whisky and Levi’s jeans.

China has not yet retaliated against the USA’s protectionist measures. This may come as a surprise, but it’s probably because of the 2018 National People’s Congress Meeting, which will end on 20 March. The government may also be waiting to see how other trading partners, such as Europe, react.

The US Federal Reserve will meet this week and is expected to announce a further tightening of monetary policy in a context of strong economic growth. The market will be looking to see whether the Fed raises its forecast for 2018 from three hikes to four.

USA: Goldilocks has gone home...

Most market pundits were extolling the merits of a Goldilocks economy at the very start of the year, but the scenario appears to have changed since then, resulting in a much less rosy outlook. Although the economy is still growing at a solid rate of at least 3%, the spectre of inflation is looming and is threatening to stay for good this time. The US Federal Reserve has its guard up, ready to raise rates more rapidly if its inflation forecast of 1.9% by the end of the year needs to be revised upwards. Interest rates have awoken from their slumber, and the market has experienced a slump and renewed volatility. Wages are the Achilles’ heel. More than 300,000 jobs were added last
month, which is a phenomenal figure. And yet unemployment still sits above 4%. But as more and more baby boomers retire, the proportion of the working population will shrink again – as it has been doing since 2000. This will cause unemployment to decline, which should push wages more sharply upwards. The unprecedented technological advances of our time could make the Fed’s work easier, although nothing is for sure. It’s worth keeping an eye on the situation. Nevertheless, our market view has not really changed. After some initial signs of exuberance in January, investor sentiment has fallen back, and the S&P 500 is trading at 17x 12-month forward earnings compared with last year’s high of 18.5x.
We are therefore reaffirming our cyclical bias. Our favourite sector, financials, will benefit directly from interest rate hikes in a growing economy. What’s more, the tech revolution could prolong the tech sector’s outperformance. And finally, energy and industrials are lagging behind and are less prized by investors. Energy stocks should nevertheless be buoyed by a rise in oil prices triggered by solid demand in emerging markets. And for industrials, economic growth combined with capital expenditure should push margins upwards. So it looks like Goldilocks has gone home. But the market can reach new highs without her.

USD: bearish sentiment

Sentiment on the US dollar is solidly bearish, and there are no bullish signs for the greenback coming from the USA at the moment. Certain members of Trump’s inner circle aren’t convinced by the president’s decisions, and some of his closest allies have even left because they don’t agree with the current occupant of the Oval Office. We think that recent political
statements have had some influence on the dollar. Yet the greenback’s softness could in fact make it easier to gradually bring US monetary policy back to normal.

However, one man’s loss is another man’s gain: further rate hikes in the States will not help the ECB, by pushing up European interest rates. The recent uptick in growth shows that this rise is perhaps for the moment not as well en
trenched as it is in the USA.

Nevertheless, an increase in European yields could upset the ECB’s efforts to stimulate the economy and inflation.

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