APRIL 2017

Quarterly Market Update: Second Quarter 2017

Market summary: Global expansion offsets political uncertainty

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The worldwide recovery in industrial activity continued to bolster the most synchronized global expansion in the past several years. While growing political uncertainty surrounding the prospects for U.S. economic policy changes caused a reversal in post-election, policy- related trades, stock market volatility remained at extremely low levels. Supported by a weaker U.S. dollar, non-U.S. equities led the Q1 global stock market rally; for the first time in years, emerging-market equities outperformed U.S. large-caps on a one-year basis.

Amid signs of moderate-but-not-overheating economic expansion, flattish bond yields helped support a solid backdrop for most asset categories. As inflation indicators firm, monetary policymakers turn less accommodative, and the U.S. business cycle becomes more mature, smaller allocation tilts are likely warranted. As the year progresses, the uncertain outlook for U.S. economic legislation and upcoming elections in core European countries—including presidential elections in France during Q2—could boost market volatility.

Theme: Crosswinds for earnings

Corporate earnings growth continues to rebound off the profit-recession lows of early 2016, but a more moderate outlook in the growth trend could be likely, owing to a combination of factors. For example, companies may have difficulty expanding profit margins from elevated levels as they face a secular peak in globalization and a cyclical pick-up in wages. While government policies can boost cyclical growth that could help company sales, the multiplier tends to be higher for stimulus when there is a large amount of economic slack and monetary policy is accommodative—unlike the current backdrop.

Moreover, boosting growth through fiscal stimulus may also be more difficult today following a sustained period of low investment. With the Federal Reserve (Fed) picking up the pace of monetary tightening, corporate interest expense may begin to rise, making it more difficult for corporations to continue to boost return-on.equity via higher levels of leverage. On the other hand, the possibility of a cut in the corporate tax rate could support further profit growth.

Economy/Macro: Continued global expansion supported by U.S. and China

The global economy continues to expand in a synchronized fashion, with most developed economies in more mature (mid to late) stages of the business cycle. China’s improved cyclical trajectory has helped boost many emerging-market economies and catalyzed a recovery in the global manufacturing, trade, and commodity industries. China’s broader activity has continued to stabilize and improve on the margin, but its policymakers’ shift to a less accommodative stance, amid continued excess capacity and corporate leverage, implies a ceiling to China’s cyclical upswing.

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