Strategy: Markets discount modest growth, gradual tightening and political continuity

07 Nov 2016

  • PMIs stronger in developed markets than in EM
  • Fed on hold for now; rate rise looks likely in December
  • Asset allocation: markets gripped by US elections

Narrowing polls and a lack of predictability as regards the eventual winner of the US presidential election increasingly kept financial markets in their grip in the run-up to polling on 8 November[1], overshadowing encouraging economic data and improving company earnings.


With most of the countries now having reported purchasing managers indices for October, our GDP-weighted global manufacturing PMI rose by one point to 52.1, marking its highest level since October 2014. Our global services PMI gained 1.4 points to 52.9, the highest since last November. Thus, the weakness in economic and trade growth seen in the first half of the year appears to be fading. Given the generally low trend growth and cyclical headwinds such as fading stimulus in China, we do not expect global growth to be strong though.

Modest growth is also what the PMIs suggest. While manufacturing PMIs have on average gained in developed and emerging markets, the improvements as well as the levels in developed economies are stronger. In our view, one of the reasons is the optimism after the UK referendum on EU membership. The pro-Brexit vote has so far had a limited impact on the UK economy. Another reason is that some emerging markets have lost growth momentum. This desynchronised growth scenario is not visible in the services PMIs since those indices are only available for a limited number of emerging economies.

In asset allocation terms, we expect emerging equities to do well over the longer term, but on a tactical basis we are neutral. We are underweight in emerging market debt in hard currency, where we see relatively low risk spreads in a challenging growth scenario and worsening fundamentals such as debt-to-GDP ratios.


In the US, the unemployment rate fell by a notch to 4.9% in October, but falling labour market participation was behind the lower rate, meaning that the figures are not as good as they seem. But the household survey data can be volatile and October’s drop did come after strong gains in the previous months, so this is not something to worry about. From a broader perspective, the fact that the unemployment rate has been roughly stable for a year and the participation rate has risen slightly could mean that the US economy is close to full employment. Encouragingly, average hourly earnings rose by 2.8% YoY for the strongest post-recession gain in wages.

We think that this labour market data is strong enough to allow the Federal Reserve to raise the fed funds rate by 25bp in December. Next month’s policy meeting will be followed by a news conference, enabling the Fed to explain any rate hike and clarify the path of US interest rates.

After this month’s policy meeting, the central bank noted that inflation had risen somewhat this year and its wording provided another intimation of impending tightening action: instead of waiting for further evidence of continued progress towards its targets, the Fed said it was waiting for just some further evidence. It said that the case for a rate rise had continued to strengthen. A rate rise in December now looks like the base case for the Fed. In other words, only severely weaker data or heightened market volatility would keep it from raising rates.


Japanese economic data has remained mixed. Consumer spending has been weak, but according to the PMI, producers have gained confidence. Nominal wage growth has averaged 0.5% YoY from January through September this year. This is not strong, but it is an improvement from falling nominal wages from 2011 to 2013 and somewhat better than the slack 2014-2015 pace. Negative inflation lifted real wage gains to 0.7% YoY in October.

However, the minutes of the September monetary policy meeting show that policymakers at the Bank of Japan are divided: they differ on the time needed to reach 2% inflation, on the efficacy of the BoJ’s massive asset purchase programme and on the BoJ’s ability to control both the yield curve and the pace of quantitative easing. We think that yields may have priority, which could actually lead to some tapering in the asset purchases. For now, markets have ignored this. Japanese equities have moved in line with global equities and the Japanese yen performed its safe-haven role as it strengthened in the latest equity sell-off.


Our core expectation of modest global growth and very gradual interest-rate rises in the US should be positive for equities, although we think this is now very much the consensus scenario for which markets are currently priced. With the risks skewed to the downside, we have maintained our cautious asset allocation.


WSU 07nov16
[1] TV stations and internet platforms including Youtube and Twitter and the Facebook pages of the main US broadcasters will provide coverage. Read more here. The first results will be announced in Dixville Notch in New Hampshire, sometimes 24 hours before the rest of the country. By midnight on 8 November, polls begin to close with predictions made based on exit polls.